The Break-Up

After a tense period of disagreement and stalemate, the threaten of litigation,[i] the ensuing economic and emotional stress, Client and their former fellow-shareholder (“Departing”) – and onetime friend, before their disagreement on the direction of the business turned into much worse – have gone their separate ways. The corporation (“Corp”)[ii] through which they once operated the business together has been divided in two, with Departing taking one part of the business, while Client remained with the other. Each of them will now be free to manage and operate their respective business without interference or objections from the other.[iii]

Thankfully, the break-up was accomplished on a tax-efficient basis; otherwise, the process would have been a lot more expensive considering the very low basis each of them has for their shares of Corp stock. Their attorneys had discussed a buyout, either by way of a cross-purchase[iv] or a redemption,[v] but that would have required third-party financing,[vi] and would have resulted in a large taxable gain to Departing.[vii] Besides, by that point, the two of them could never have agreed on a price for the shares (though Client seems to recall a provision in that draft shareholders’ agreement, that was never executed, which set forth a process for determining the value of the corporation).[viii] Client had also considered a sale by Corp to Departing of those assets needed for that part of the business in which Departing was most interested, and which proved to be the root cause of their disagreement. However, this too would have generated significant taxable gain.[ix]

Then Client met with their tax adviser.[x]

After consulting with the adviser, and pursuant to written agreement, Corp formed a subsidiary corporation (“Sub”) to which it contributed the business assets that Departing wanted;[xi] in exchange for this contribution, Sub issued all of its stock to Corp, and Corp then distributed all of the Sub stock to Departing in exchange for all of Departing’s shares of Corp stock. As a result of this transaction – the tax adviser called it a “divisive reorganization” or a “split-off”[xii] – Client was left as the sole shareholder of Corp while Departing became the sole shareholder of Sub. It’s true that Corp also had to distribute some cash to Departing in order to fully compensate Departing for their shares in Corp, but that was a small price to pay.[xiii]

The tax adviser explained that the foregoing transaction would be treated as a “reorganization”[xiv] and would not be taxable to Client,[xv] to Corp,[xvi] or to Sub, and that Departing would recognize any gain realized on the exchange only to the extent of the “equalizing” cash distribution.[xvii]

The adviser also explained that certain information would have to be filed with the tax returns for the year of the transaction by each corporation and exchanging shareholder involved in the reorganization.[xviii] Client thought, “I’ll let the accountants worry about that.”

Finally, the tax adviser said something about “It ain’t over til the cows sing,” which Client interpreted as a warning that something may still go wrong, that some post-reorganization event may trigger an adverse tax result. At the same time, however, Client knew how the adviser regularly mangles idioms;[xix] still, they wondered what the adviser meant – who wouldn’t, right?

A few months later, Client finds out that Departed (formerly Departing) may be selling C to a competitor and moving to Florida.[xx] Client calls their tax adviser and informs them of this development, to which the adviser replies, “I guess the cows are coming home.” Again, Client doesn’t fully grasp the adviser’s meaning, but recognizes that it can’t be good.

Tax-Free Division

In order to appreciate the import of this last exchange between the tax adviser and Client, it will help to first review the many requirements that have to be satisfied in order for the above-described divisive reorganization of Corp to receive favorable income tax treatment:

• In general, the distributing parent corporation (Corp or “D”) must distribute to some or all of its shareholders (Departing) all of the stock of a subsidiary corporation (Sub or “C”) that was controlled by D immediately prior to the distribution (the “Distribution”);
• D and C must each be engaged in the “active conduct of a trade or business” immediately after the Distribution;[xxi]
• Neither D’s nor C’s active trade or business was acquired in a taxable transaction during the five-year period preceding the Distribution;[xxii]
• There is a corporate business purpose[xxiii] for the Distribution that cannot be accomplished by another nontaxable alternative which is neither impractical, nor unduly expensive;[xxiv]
• Immediately following the Distribution, neither D nor C has investment assets the FMV of which is two-thirds or more of the FMV of all of the corporation’s assets;
• The distributee-shareholders (Departed) did not acquire their D shares by “purchase” during the five-year period ending on the date of the Distribution;[xxv]
• The transaction must not be used principally as a “device” for the distribution of the earnings and profits of either D or C (the “device” test);
• D’s pre-Distribution shareholders (Client and Departed) must maintain a sufficient degree of stock ownership in both D and C following the Distribution (the “continuity of interest” test);[xxvi]
• The Distribution is not made pursuant to a plan by which at least 50-percent of D’s or C’s stock will be acquired by third parties (the “disguised sale” test);[xxvii] and
• Following the Distribution, D must continue the business it retained, while C must continue the business transferred to it by D.[xxviii]

In general, if these requirements are satisfied, (1) Departed will not recognize gain or loss upon the receipt of the C stock,[xxix] (2) D will not recognize gain or loss upon the funding of C, or upon the distribution of the C stock to Departed, (3) the assets contributed by D to C will have the same basis in C’s hands as they had in D’s immediately before the contribution,[xxx] (4) the aggregate basis of the C stock received by Departed in the Distribution will equal their aggregate basis in the D stock surrendered in the Distribution,[xxxi] and (5) the holding period of the C stock received by Departed will include the holding period of their D stock.[xxxii]

Post-Distribution Acquisition

A glance at the foregoing list[xxxiii] should alert D’s pre-Distribution shareholders – Client and Departed – that the satisfaction of some of these requirements may be dependent upon events that occur (or don’t occur) after the Distribution.

Where the specific post-Distribution event at issue is Departed’s sale of C’s stock – as posited above – the satisfaction of any one of the following tests may be called into question:

• The device test;
• The continuity of interest test; and
• The disguised sale test.

If the IRS were to find that the divisive reorganization failed any one of these tests,[xxxiv] the transaction would not qualify for the favorable tax treatment described above. We’ll consider each of these in turn.

Device Test

The Code denies tax-free treatment where Distribution is used principally as a “device” for the distribution of the earnings and profits of D and/or C.[xxxv] This rule is intended to prevent a shareholder from removing corporate income – that might otherwise have been distributed as a dividend – through post-Distribution sales of C stock which allow a shareholder to recover the basis for their shares.[xxxvi]

According to the Code, “the mere fact” that stock in either D or C is sold by Departed subsequent to the Distribution, “other than pursuant to an arrangement negotiated or agreed upon prior to the [Distribution] shall not be construed to mean that the transaction was used principally as a . . . device.”[xxxvii]

The determination of whether a divisive reorganization was used principally as a device will be based on all the facts and circumstances. The regulations list both “device factors,” tending to indicate that a transaction is a device,[xxxviii] and “nondevice factors,” tending to indicate that the transaction is not a device.[xxxix] These factors are weighed against each other.

The prearranged sale by Departed of their stock in C would be considered “substantial evidence” of device, whereas a stock sale that was not prearranged would nonetheless be considered “evidence of device.”[xl] Either way, the Distribution and the later sale must somehow be connected in order to rise to the level of a device; this presents a question of fact.

In general, the greater the percentage of C stock sold, and the closer in time to the Distribution that the sale of C occurs, the stronger the evidence of device.[xli]

Significantly, a post-Distribution sale of C may be treated as having been effectuated “pursuant to an arrangement negotiated or agreed upon before the distribution,” even though enforceable rights to buy or sell the C stock did not exist at the time of the spin-off, if the sale was discussed before the Distribution and was “reasonably to be anticipated by both parties.”[xlii]

By reason of certain “non-device” factors in the regulations, however, the post-Distribution sale of C stock may not trigger a device problem, even where the sale occurs soon after the distribution. The presence of these factors tends to negate the existence of a device, though the strength of the nondevice evidence will depend upon all the facts and circumstances, and must be balanced against the evidence of device.

For example, although the “business purpose” requirement exists independently of the device test,[xliii] the regulations recognize a relationship between the device test and the business purpose requirement.[xliv] Specifically, a strong corporate business purpose for the Distribution is generally evidence that the transaction was not used principally as a device for the distribution of earnings and profits, and may outweigh the presence of device factors.[xlv] However, the stronger the evidence of device, the stronger the corporate business purpose that may be required to prevent a determination that the transaction was used as a device.[xlvi]

Continuity of Interest

The sale of the C stock received by Departing in the Distribution may also implicate the continuity of interest requirement.[xlvii]

The regulations[xlviii] state that “Section 355 applies to a separation that effects only a readjustment of continuing interests in the property of [D and C].” This requires that, after the Distribution, “one or more persons who . . . were the owners of” D before the Distribution – i.e., Client and Departed – “own, in the aggregate, an amount of stock establishing a continuity of interest in each of” D and C after the Distribution. However, it is not necessary for the same pre-Distribution shareholders of D to satisfy the continuity requirement for both D and C after the Distribution; rather, the test is satisfied so long as some D shareholders (Client) retain a meaningful continuing interest in D, while others (Departed) do so as to C.[xlix] After all, this is a divisive reorganization.

Of course, “continuity” requires a certain degree of stock ownership. For advance ruling purposes, the IRS considers continuity of interest to exist when one or more persons who were the owners of D before the Distribution own, in the aggregate, 50-percent or more of the stock in each of D and C after the Distribution.[l] Likewise, although the regulations do not establish a minimum required continuity, they also indicate that 50-percent continuity is sufficient.[li]

Viewed as of the date of the Distribution only, this requirement should not present an issue. However, where the stock of C is sold shortly after the Distribution, the IRS and the courts have always looked beyond the time of the Distribution itself.

Specifically, they will examine the period preceding the Distribution to see if Departed had any discussions with potential buyers during that time which might lead to the conclusion that Departed never intended to hold the C stock. They will try to ascertain whether Departed had obligated themselves to sell the stock.

Alternatively, they will consider the period following the Distribution to see if anything unexpected occurred – whether in C’s industry or in the economy generally, for example – that might have created a situation in which the sale of the C stock should not be interpreted as a violation of the continuity of interest test.

Depending on the outcome of this examination of the surrounding circumstances, the reorganization may fail the continuity of interest test on account of the post-Distribution sale of C stock.

The IRS has always treated a post-Distribution sale – like Departed’s sale of the C stock – as a significant factor in determining whether the continuity of interest test was satisfied in the case of a divisive reorganization. Thus, for advance ruling purposes, taxpayers are asked to represent that there is no plan or intention by D’s shareholders to sell, exchange, or otherwise dispose of any of their stock in C after the transaction.[lii]

Applying basic continuity of interest principles[liii] – including variations of the step transaction doctrine[liv] – where a former D shareholder is obligated at the time of the Distribution to sell their C stock to a third party after the Distribution, the continuity test is not satisfied.

By the same token, where there is no such obligation to sell the C stock, one must consider the overall facts and circumstances to discern the former D shareholder’s intent with respect to the C stock. For example, a sale of the stock shortly after the Distribution may indicate to the IRS – which almost always has the benefit of hindsight – that Departed intended to sell the C stock which, the IRS would assert, violated the continuity of interest rule.

In that case, Departed may be faced with the challenge of trying to establish that they did not intend to sell the C stock at the time of the Distribution, but that circumstances changed unexpectedly after the Distribution, such that the shareholder’s original plan or intention with respect to the C stock was no longer viable or sensible.

Even where the former D shareholder had no plan, as of the date of the Distribution, to sell the C stock – meaning that their intention was to hold such stock – the question remains: how long after the Distribution must they hold the C stock to satisfy the continuity of interest test? Unfortunately, there is no clear answer. In the absence of a significant change in circumstances, the longer the better, though two years is generally considered a safe period.

Disguised Sale

The Code denies tax-free treatment to any distribution of C stock that is a component of a divisive reorganization of D if it is part of a plan (or series of related transactions) pursuant to which one or more persons acquire stock in C (or D) that represents a 50-percent or greater interest in C (or D).[lv] In other words, this rule causes D to be taxed on the Distribution.

What’s more, the Code establishes a presumption that such a plan exists if one or more persons acquire 50% or more of the stock of C during the four-year period beginning two years before a spin-off and ending two years after the spin-off,[lvi] “unless it is established that the distribution and acquisition are not pursuant to a plan or series of related transactions.”

Whether a distribution and an acquisition are part of a “plan” is determined based on all the facts and circumstances surrounding the transactions. The regulations set forth a non-exhaustive list of facts and circumstances to be considered in determining whether a distribution and an acquisition are part of a plan. In general, the weight to be given each of the facts and circumstances depends on the particular case. Whether a distribution and an acquisition are part of a plan does not depend on the relative number of facts and circumstances that evidence that a distribution and an acquisition are part of a plan as compared to the relative number of facts and circumstances that evidence that a distribution and an acquisition are not part of a plan.[lvii]

That being said, and before turning to the plan and non-plan factors referenced above, it is important to note that the regulations provide, in the case of an acquisition after a distribution – as in the case of the sale by Departed of the C stock after the Distribution – that the distribution and the acquisition can be part of a plan only if there was an agreement, understanding, arrangement, or substantial negotiations[lviii] regarding the acquisition of C, or a “similar” acquisition,[lix] at some time during the two-year period ending on the date of the distribution. Therefore, in the absence of such an agreement, understanding, arrangement, or substantial negotiations during the two-year period ending with the Distribution, the sale of C after the Distribution should not run afoul of the disguised sale rule.

That being said, in the case of an acquisition after a distribution, the existence of an agreement, understanding, etc., regarding the acquisition or a similar acquisition at some time during the two-year period ending on the date of the distribution tends to show that the distribution and the acquisition were part of a plan. The weight to be accorded this fact will depend on the nature, extent, and timing of the agreement, understanding, etc., though the existence of any of these “at the time of the distribution is given substantial weight.”[lx]

However, it is still possible for the taxpayer to establish, based on all facts and circumstances, that the distribution and the acquisition were not part of a plan; for example, if the distribution was motivated in whole or substantial part by a corporate business purpose other than a business purpose to facilitate the acquisition of C, and would have occurred at approximately the same time and in similar form regardless of whether the acquisition was effected.[lxi]

Of course, the fact that the distribution was motivated by a business purpose to facilitate the subsequent acquisition tends to show that the distribution and acquisition were part of a plan.[lxii]

On the other hand, one also has to consider those factors tending to show that a distribution and an acquisition occurring after the distribution are not part of a plan. For example,

• There was an identifiable, unexpected change in market or business conditions occurring after the distribution that resulted in the acquisition that was otherwise unexpected at the time of the distribution.
• The distribution was motivated in whole or substantial part by a corporate business purpose other than a business purpose to facilitate the acquisition.
• The distribution would have occurred at approximately the same time and in similar form regardless of the acquisition.[lxiii]

In order to provide taxpayers greater certainty as to certain post-distribution sales, the regulations promulgated under the disguised sale rules also set forth the following safe harbors:[lxiv]

• (a) The Distribution was motivated in whole or substantial part by a corporate business purpose other than to facilitate an acquisition of C; (b) the acquisition of C occurs more than six months after the Distribution; and (c) there was no agreement, understanding, arrangement or substantial negotiations concerning the acquisition or a similar acquisition during the period that begins one year before, and ends six months after, the Distribution.
• (a) The distribution was not motivated by a business purpose to facilitate the acquisition or a similar acquisition; (b) the acquisition occurs more than six months after the Distribution; and (c) during the period beginning one year before and ending six months after the Distribution, there was no agreement, understanding, arrangement or substantial negotiations concerning the acquisition or a similar acquisition; and (d) no more than 25-percent of the stock of the acquired corporation was acquired during such 18-month period.
• (a) There was no agreement, understanding, or arrangement concerning the acquisition or a similar acquisition at the time of the Distribution; and (b) there was no agreement, understanding, arrangement or substantial negotiations concerning the acquisition or a similar acquisition within one year after the Distribution.[lxv]

Did The Cows Sing or Come Home?

If, as of the date of the Distribution, at least, the division of Corp otherwise satisfied the criteria for a tax-free divisive reorganization, would the subsequent sale of the C stock by Departed result in a taxable division by causing the transaction to violate any of the device, continuity of interest and disguised sale tests?

Based on the facts provided, above, it is difficult to say. The fact of a sale shortly after the Distribution would be a negative factor, though we have no information regarding the impetus for the sale. Moreover, we do not know whether Departed had any discussions with the prospective acquirer of C prior to the Distribution, the nature thereof, or whether any agreement was reached. We do know that Client’s and Corp’s only purpose for the division was to enable the two shareholders and their respective business interests to go their separate ways, not to facilitate a sale.

Thankfully, the idiom-challenged tax adviser foresaw some of the risks that would be posed by a subsequent sale, and tried to address them as much as possible in the negotiations that preceded the Distribution.

For one thing, the adviser ensured, as the saga between the two shareholders unfolded and during the preparation of reorganization agreements, that the business purpose for the transaction was well documented and substantiated.

The adviser also succeeded in convincing Departing to include in the agreement (i) representations that they had not engaged in any discussions with any person up until then regarding a disposition of C, and had no present plan or intention of selling C, or of causing C to sell its assets,[lxvi] after the Distribution; (ii) a covenant that, for the two-year period following the Distribution, Departing would not transfer any C stock without first notifying Corp and Client, and providing an opinion of counsel, acceptable to Corp and Client, that the proposed sale would not compromise the tax-free divisive reorganization;[lxvii] (iii) a covenant that the parties would report the Distribution consistently with the agreement and would not take any action that may reasonably be expected to jeopardize the tax-free reorganization; and (iv) indemnity provisions in case of a breach of any of the foregoing.

With these provisions in place, the cows may eventually feel like singing. Whether they do so at home or elsewhere is beside the point.

[i] Including, perhaps, a petition for dissolution under NY-BSC Sec. 1104, on the ground that the shareholders were deadlocked.

[ii] Do you recall the name of John Wayne’s character’s canine sidekick in the movie Big Jake? “Dog.”

[iii] A classic “fit and focus” business purpose. See Rev. Proc. 96-30, Appendix A.

[iv] I.e., a purchase and sale of shares of stock between the two shareholders.

[v] In which the corporation would have purchased its stock from the departing shareholder, resulting in a complete termination of the seller’s equity interest in the corporation. IRC Sec. 302(b)(3).

[vi] For example, a bank loan, and its attendant costs (including ongoing interest payments and financial covenants).

[vii] IRC Sec. 1001. Probably a long-term capital gain because the stock represented a capital asset in the hands of the selling shareholder. IRC Sec. 1221. Such gains are taxed at a federal rate of 20-percent. If the issuing corporation is a C corporation, the 3.8-percent surtax on net investment income will also apply. Assuming the seller is a resident of N.Y. City, the maximum State tax rate on personal income (whether ordinary income or capital gain) is 8.82-percent, while the City rate is 3.876-percent.

[viii] I’m not gonna say it. You won’t hear “I told you so,” from me. Nope. No way.

[ix] For the selling-corporation, and perhaps for the departing shareholder if the transfer by the corporation was made, in part, in redemption of the buyer’s shares. Of course, if the corporation were an S corporation, the remaining shareholder would be allocated their share of the corporation’s gain. IRC Sec. 1366.

[x] “A dog who thinks he is a man’s best friend is a dog who obviously has never met a tax lawyer.” – Fran Lebowitz.

[xi] Of course, Corp also “transferred” to Sub, and Sub accepted, the liabilities associated with the assets. For purposes of this discussion, we will not be focusing on the treatment of such liabilities.

[xii] In general, a “spin-off” describes what will usually be a pro rata distribution by a parent corporation of the stock of a subsidiary corporation to the parent corporation’s shareholders, following which the two corporations may be described as brother-sister corporations (because of their overlapping ownership); a split-off describes a distribution in which one of more of the parent’s shareholders exchange all of their parent stock for stock in the distributed subsidiary corporation (though some shareholders may continue to own stock in both corporations); a split-up may be described as the liquidation of the parent corporation, in which it distributes all of the stock of two or more subsidiary corporations to its shareholders in liquidation of their parent stock.

[xiii] So-called “boot.”

[xiv] Described in IRC Sec. 368(a)(1)(D) and Sec. 355. A corporation is generally required to recognize gain on the distribution of property (including stock of a subsidiary) as if the property had been sold for its fair market value. See, e.g., IRC Sec. 311(b). The shareholders generally treat the receipt of the property as a taxable event as well. Section 355 provides an exception to this general rule.

[xv] No sale or exchange of any property.

[xvi] IRC Sec. 361; see also Sec. 355(c).

[xvii] IRC Sec. 355(a) and IRC 356.

[xviii] Reg. Sec. 1.368-3 and Reg. Sec. 1.355-5.

[xix] “Behind the cue ball” and “beating a horse to death” are two of the better-known examples of the adviser’s missteps in the world of idioms.

[xx] Hopefully, Departed consulted their own advisers before doing so. https://www.taxlawforchb.com/2019/07/escape-from-new-york-it-will-cost-you/

[xxi] Actively conducted for at least five years prior to the distribution, and that was not acquired by D or C during that period in a transaction in which any gain or loss was recognized. IRC Sec. 355(b).

[xxii] Though the expansion of an existing qualifying business may, generally, be effected through such an acquisition.

[xxiii] Reg. Sec. 1.355-2(b). As distinguished from a shareholder purpose. There are times when these will overlap, especially in the context of a family-owned corporation.

[xxiv] Rev. Proc. 96-30.

[xxv] IRC Sec. 355(d).

[xxvi] Reg. Sec. 1.355-2(c).

[xxvii] IRC Sec. 355(e); Reg. Sec. 1.355-7.

[xxviii] Reg. Sec. 1.368-1(d). The “continuity of business enterprise” test.

[xxix] IRC Sec. 355(a). Except to the extent on any boot received. IRC Sec. 356.

[xxx] IRC Sec. 362.

[xxxi] IRC Sec. 358.

[xxxii] IRC Sec. 1223.

[xxxiii] Or at the underlying regulations in some cases.

[xxxiv] Truth be told, if the sale of C violated one of these three tests, odds are that all three have been violated.

[xxxv] IRC Sec. 355(a)(1)(B); Reg. Sec. 1.355-2(d).

[xxxvi] Reg. Sec. 1.355-2(d)(1). A dividend does not allow for basis recovery. See also IRC Sec. 302 and Sec. 301.

[xxxvii] IRC Sec. 355(a)(1)(B). It follows that an arrangement agreed upon prior to the distribution is not a good fact.

[xxxviii] Reg. Sec. 1.355-2(d)(2).

[xxxix] Reg. Sec. 1.355-2(d)(3).

[xl] Reg. Sec. 1.355-2(d)(2)(iii)(B)-(C).

[xli] Reg. Sec. 1.355-2(d)(2)(iii)(A).

[xlii] Reg. Sec. 1.355-2(d)(2)(iii)(D).

[xliii] Reg. Sec. 1.355-2(b).

[xliv] Reg. Sec. 1.355-2(d)(3)(ii).

[xlv] Reg. Sec. 1.355-2(b)(4).

[xlvi] Thus, strong device factors may overcome a weak business purpose.

[xlvii] As indicated earlier, the continuity of interest requirement is an independent requirement for IRC Sec. 355 qualification.

[xlviii] Reg. Sec. 1.355-2(c)(1).

[xlix] Reg. Sec. 1.355-2(c)(2), Ex. 1.

[l] Rev. Proc. 96-30.

[li] This should be distinguished from the acquisitive reorganization provisions, for which the continuity of interest test is applied differently.

[lii] Rev. Proc. 96-30. For purposes of the fact pattern considered herein, a more accurate representation would be that the former D shareholder (Departed) had no plan or intention to dispose of a number of shares of C stock received in the Distribution that would reduce their ownership of C stock to a number of shares having a value, as of the date of the Distribution, of less than 50-percent of the value of all of the C stock as of the same date.

[liii] Which are still applicable to divisive reorganizations, but which have been somewhat relaxed for acquisitive reorganizations.

[liv] Under this doctrine, a set of pre-arranged transactional steps (some of which may lack economic substance) may be collapsed or stepped together to arrive at the same end-result, though with a less favorable income tax outcome for the taxpayer. The problem from the taxpayer’s perspective is the uncertainty inherent in the application of the doctrine. Those transactions that include steps that are undertaken solely for their tax consequences are clear candidates. Others are more difficult to ascertain.

[lv] IRC Sec. 355(e); Reg. Sec. 1.355-7. The focus herein will be on C. The rationale behind this provision is simple: the reorganization provisions are intended to permit a tax-free division of an existing business arrangement among existing shareholders. In cases in which it is intended that new persons will acquire ownership of a business in connection with the division, the transaction more closely resembles a sale by the corporation of the portion of the business that is acquired by the new persons.

[lvi] IRC Sec. 355(e)(2)(B). The rule also covers the sale of D stock, but for our purposes we are focusing on C.

[lvii] Reg. Sec. 1.355-7(b)(1). In other words, one factor may outweigh other contrary factors.

[lviii] Reg. Sec. 1.355-7(b)(2). Whether an agreement, understanding, or arrangement exists depends on the facts and circumstances. It requires the involvement of persons authorized to act on behalf of C and their authorized counterparts at the acquirer. The parties do not necessarily have to have entered into a binding contract or have reached agreement on all significant economic terms to have an agreement, understanding, or arrangement. However, an agreement, understanding, or arrangement clearly exists if a binding contract to acquire stock exists.

Substantial negotiations in the case of an acquisition generally require discussions of significant economic terms by persons authorized to act on behalf of C with persons who are authorized to act on behalf of the acquirer. See Reg. Sec. 1.355-7(h)(1).

[lix] In general, an actual acquisition is similar to another potential acquisition if the actual acquisition effects a combination of all or a significant portion of the same business operations as the combination that would have been effected by such other potential acquisition. However, in general, an actual acquisition is not similar to another acquisition if the ultimate owners of the business operations with which C is combined in the actual acquisition are substantially different from the ultimate owners of the business operations with which C was to be combined in such other acquisition. Reg. Sec. 1.355-7(h)(12).

[lx] Reg. Sec. 1.355-7(b)(3)(i).

[lxi] Reg. Sec. 1.355-7(b)(2).

[lxii] Reg. Sec. 1.355-7(b)(3)(v).

[lxiii] Reg. Sec. 1.355-7(b)(4).

[lxiv] Reg. Sec. 1.355-7(d). These are the ones applicable to transactions between closely held corporations.

[lxv] There are a lot of nuances in these safe harbors – read them carefully.

[lxvi] Other than in the ordinary course.

[lxvii] Client made the same representations and covenants as to Corp for the benefit of Departing.

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