TESTS ARE PROVIDED FOR CONTINGENT OR ESCROWED STOCK ARRANGEMENTS IN CORPORATE REORGANIZATIONS

Rev. Proc. 84-42

SECTION 1. BACKGROUND

01 Rev. Proc. 77-37, 1977-2 C.B. 568, sets forth certain operating rules of the Internal Revenue Service pertaining to issuing ruling letters and in determining whether it should decline to issue ruling letters.

02 Rev. Proc. 84-22, 1984-13 I.R.B. 18, sets forth areas in which advance rulings or determination letters will not be issued by the Internal Revenue Service. Section 5 of Rev. Proc. 84-22 is entitled, Areas Under Extensive Study in which Rulings or Determination Letters Will Not Be Issued Until the Service Resolves the Issue Through Publication of a Revenue Ruling, Revenue Procedure, Regulations or Otherwise.

SECTION 2. PROCEDURE

01 Section 3.03 of Rev. Proc. 77-37 is amplified to read as follows:

In transactions under sections 368(a)(1)(A), 368(a)(1)(B), 368(a)(1)(C), 368(a)(1)(D), and 368(a)(1)(E), and 351 of the Code, it is not necessary that all the stock which is to be issued in exchange for the requisite stock or property, be issued immediately provided (1) that all the stock will be issued within 5 years from the date of transfer of assets or stock for reorganization under sections 368(a)(1)(A), 368(a)(1)(C), 368(a)(1)(D), and 368(a)(1)(E) or within 5 years from the date of the initial distribution in the case of transactions under sections 368(a)(1)(B) and 351; (2) there is a valid business reason for not issuing all the stock immediately, such as difficulty in determining the value of one or both of the corporations involved in the transaction; (3) the maximum number of shares which may be issued in the exchange is stated; (4) at least 50 percent of the maximum number of shares of each class of stock which may be issued is issued in the initial distribution; (5) the agreement evidencing the right to receive stock in the future prohibits assignment (except by operation by law) or if the agreement does not prohibit assignment, the right must not be evidenced by negotiable certificates of any kind and must not be readily marketable; (6) such right can give rise to the receipt only of additional stock of the corporation making the underlying distribution; (7) such stock issuance will not be triggered by an event the occurrence or nonoccurrence of which is within the control of shareholders; (8) such stock issuance will not be triggered by the payment of additional tax or reduction in tax paid as a result of a Service audit of the shareholders or the corporation either (a) with respect to the reorganization or section 351 transaction in which the contingent stock will be issued, or (b) when the reorganization or section 351 transaction in which the contingent stock will be issued involves persons related within the meaning of section 267(c)(4) of the Code; and (9) the mechanism for the calculation of the additional stock to be issued is objective and readily ascertainable. Stock issued as compensation, royalties or any other consideration other than in exchange for stock or assets will not be considered to have been received in the exchange. Until the final distribution of the total number of shares of stock to be issued in the exchange is made, the interim basis of the stock of the issuing corporation received in the exchange by the shareholders (not including that portion of each share representing interest) will be determined, pursuant to section 358(a), as though the maximum number of shares to be issued (not including that portion of each share representing interest) has been received by the shareholders.

In connectoin with item 3.03(8) above, the Service reserves the right to refuse to rule if, based on all the facts and circumstances of a case, it is determined that the principal purpose of the triggering mechanism is the reduction in federal income taxes (see section 3.02(1) of Rev. Proc. 84-22, 1984-13 I.R.B. 18).

02 Section 3.06 of Rev. Proc. 77-37 is amplified to read as follows:

In transactions under section 368(a)(1)(A), 368(a)(1)(B), 368(a)(1)(C), 368(a)(1)(D), 368(a)(1)(E), and 351 of the Code, a portion of the stock issued in exchange for the requisite stock or property may be placed in escrow by the exchanging shareholders, or may be made subject to a condition pursuant to the agreement, or plan of reorganization or of the transaction, for possible return to the issuing corporation under specified conditions provided (1) there is a valid business reason for establishing the arrangement; (2) the stock subject to such arrangement appears as issued and outstanding on the balance sheet of the issuing corporation and such stock is legally outstanding under applicable state law; (3) all dividends paid on such stock will be distributed currently to the exchanging shareholders; (4) all voting rights of such stock (if any) are exercisable by or on behalf of the shareholders or their authorized agent; (5) no shares of such stock are subject to restrictions requiring their return to the issuing corporation because of death, failure to continue employment, or similar restrictions; (6) all such stock is released from the arrangement within 5 years from the date of consummation of the transaction (except where there is a bona fide dispute as to whom the stock should be released); (7) at least 50 percent of the number of shares of each class of stock issued initially to the shareholders (exclusive of shares of stock to be issued at a later date as described in .01 above) is not subject to the arrangement; (8) the return of stock will not be triggered by an event the occurrence or nonoccurrence of which is within the control of shareholders; (9) the return of stock will not be triggered by the payment of additional tax or reduction in tax paid as a result of a Service audit of the shareholders or the corporation either (a) with respect to the reorganizatoin or section 351 transaction in which the escrowed stock will be issued, or (b) when the reorganization or section 351 transacton in which the escrowed stock will be issued involves persons related within the meaning of section 267(c)(4) of the Code; and (10) the mechanism for the calculation of the number of shares of stock to be returned is objective and readily ascertainable.

In connection with item 3.06(9) above, the Service reserves the right to refuse to rule if, based on all the facts, and circumstances of a case, it is determined that the principal purpose of the triggering mechanism is the reduction in federal income taxes (see section 3.02(1) of the Rev. Proc. 84-22, 1984-13 I.R.B. 18).

03 Rev. Proc. 84-22 is hereby modified by deleting section 5.18 which reads "Section 368.--Definitions Relating to Corporate Reorganization.--The tax consequences of a transaction intended to qualify as a reorganization under section 368(a) (1)(E) of the Code when the plan of reorganization provides for the use of contingent or escrow stock arrangements, and where the share adjustment is triggered by an event the occurrence or non-occurrence of which is within the control of the shareholders or is triggered by a Service audit of the shareholders or the corporation."

SECTION 3. EFFECTIVE DATE

This revenue procedure will apply to all ruling requests on hand in the National Office on May 14, 1984, the date of publication of this revenue procedure in the Internal Revenue Bulletin, as well as to requests received thereafter.

SECTION 4. EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 77-37 is amplified and Rev. Proc. 84-22 is modified.