The IRS has provided safe harbor valuation methods for issuing corporation stock received by a target corporation’s shareholders for purposes of determining if there is continuity of interest (COI). Under the circumstances described in the procedure, the IRS will not challenge the taxpayer’s use of one of these methods instead of using the stock’s actual trading price on a particular day.
This revenue procedure is effective with respect to transactions with an effective date on or after January 23, 2018.
Generally, to determine if the COI requirement is satisfied in a potential reorganization, the value of the stock of the issuing corporation (the acquiring corporation or its parent in the case of a triangular reorganization) received by the shareholders of the target corporation is compared to the aggregate value of the consideration the target shareholders received.
A special signing date rule applies if a binding contract to effect a potential reorganization provides for fixed consideration to be exchanged for the target shareholders’ proprietary interests (Reg. §1.368-1(e)(2)). If this rule applies, the consideration is valued as of the end of the last business day before the first date there is a binding contract (pre-signing date), rather than on the effective date of the reorganization (the closing date). Thus, a change between the signing date and the closing date in the value of the issuing corporation stock does not affect the determination of whether the COI requirement is satisfied.
Closing Date Rule
Before the signing date rule, determining whether the COI requirement was met was based on the value of the issuing corporation stock on the effective date of the reorganization (the closing date rule) (Rev. Proc. 77-37, 1977-2 CB 568). Under this rule, a decline in the value of the issuing corporation stock between the date a contract to effect a potential reorganization became binding (the signing date) and the closing date could cause a transaction to fail the COI requirement.
Proposed regulations (NPRM REG-124627-11, December 19, 2011) would have allowed parties to a potential reorganization to use an average of the trading prices of issuing corporation stock over a number of days, instead of its actual trading price on the closing date, when determining whether the COI requirement is met.
Transactions Eligible for the Safe Harbor
A taxpayer may rely on the safe harbor provided by this revenue procedure if either the signing date rule or the closing date rule apply to the transaction. In addition, the following requirements must also be satisfied:
- The target shareholders receive issuing corporation stock and money and/or other property in exchange for their target stock in a transaction that, except for the COI requirement, would qualify as an “A”, “B”, “C” or acquisitive “G” reorganization.
- The issuing corporation’s stock that is exchanged for the target shareholders’ stock is traded on a national securities exchange (exchange traded stock).
- All parties to the potential reorganization treat the transaction in a consistent manner.
- The transaction is effected pursuant to a contract that is binding on the parties no later than the beginning of the first trading day of the measuring period selected by the parties, and evidences the parties’ agreement as to certain terms, including the safe harbor valuation method and an appropriate measuring period that will be used to determine the value of each class of exchange traded stock to be received by the target shareholders.
- The contract terms are fulfilled at the closing date, in all material respects.
Safe Harbor Valuation Methods and Measuring Period
The safe harbor in this procedure may be used by taxpayers using one of the following safe harbor methods to value exchange traded stock:
(1) Average of the Average High-Low Daily Prices.
(2) Average of the Daily Closing Prices.
Generally, the measuring period is at least five but not more than 35 consecutive trading days (based on the trading days of the specified exchange) used in connection with a safe harbor valuation method.
If a taxpayer satisfies the safe harbor requirements, the IRS will not challenge the taxpayer’s valuation of exchange traded stock under the safe harbor method and measuring period selected by the parties, when determining whether the COI requirement is met. The safe harbor is available whether or not the value of the exchange traded stock so determined satisfies the COI requirement.
Scope and Effect of the Revenue Procedure
The safe harbor provided in this revenue procedure may only be used to determine whether the COI requirement is satisfied. In addition, the safe harbor may be applied only to transactions that satisfy the requirements of the procedure. Finally, the safe harbor may only be used to determine the value of exchange traded stock under a safe harbor valuation method using the appropriate measuring period.
Moreover, if the safe harbor does not apply, whether a transaction satisfies the COI requirement is determined using general federal tax principles without regard to this revenue procedure.
Subject to the general letter ruling policy and procedures, the IRS will entertain ruling requests on transactions and legal issues to which the safe harbor does not apply. It will also accept ruling requests regarding the applicability of the safe harbor.
This revenue procedure further amplifies Rev. Proc. 77-37, 1977-2 CB 568, as amplified by Rev. Proc. 86-42, 1986-2 CB 722, and Rev. Proc. 89-50, 1989-2 CB 631.
Rev. Proc. 2018-12