Rev. Proc. 81-70

SECTION 1. PURPOSE

This revenue procedure sets forth guidelines for estimating the basis of stock acquired by an acquiring corporation in a reorganization described in section 368(a)(1)(B) of the Internal Revenue Code.

SEC. 2. BACKGROUND Section 368(a)(1)(B) of the Code defines a reorganization as the acquisition by one corporation of stock of another corporation solely in exchange for part or all of the voting stock of either the acquiring corporation or its parent, provided the acquiring corporation has control of the acquired corporation immediately after the acquisition. Section 354(a)(1) provides for nonrecognition of gain or loss on the exchange of stock or securities of one corporate party to a reorganization for stock or securities of another corporate party to the reorganization. Section 362(b) provides that the basis of stock or securities received by a corporate party to a reorganization will be the same as the basis was in the hands of the transferor if part or all of the consideration for the transfer consisted of stock or securities of the acquiring corporation or its parent. Section 1.368-3(a) of the Income Tax Regulations requires each corporate party to the reorganization to file, as part of its return for the tax year in which the reorganization occurred, a complete statement of all facts pertinent to the nonrecognition of gain or loss in connection with the reorganization, including information about the basis of stock transferred and the amount of stock received.

Two problems may be encountered by the acquiring corporation in complying with the basis requirements of a "B" reorganization because the information necessary to establish the basis of the acquired corporation's stock is in the possession of the former shareholders of the acquired corporation. The first problem is that some of the former shareholders of the acquired corporation may not respond to the acquiring corporation's request that they furnish to it their basis in the acquired corporation's stock. Thus, through no fault of its own, the acquiring corporation does not possess the documentary proof to establish its basis in that stock. It is well established that when a taxpayer has realized income or incurred an expense but does not possess documentary proof of it, the taxpayer has been permitted to estimate such items from the best secondary evidence available. The burden of producing this evidence and justifying the estimations based on the evidence falls on the taxpayer, and any doubts are resolved against the taxpayer. See Cohan v. Commissioner, 39 F. 2d 540 (2nd Cir. 1930), Prosperity Co. v. Commissioner, 17 T.C. 171 (1951), acq. 1951-2 C.B. 3, and Rev. Rul. 54-497, 1954-2 C.B. 75. Under these principles, it is appropriate to permit the acquiring corporation in a "B" reorganization to estimate the basis of stock of nonresponding shareholders.

The second problem is that under certain circumstances, particularly when the stock of the acquired corporation is widely held, it is time consuming, burdensome, and costly for the acquiring corporation to contact each former shareholder of the acquired corporation to obtain the basis of the stock each held. The Internal Revenue Service has authorized the use of statistical sampling techniques in other situations in which the administrative costs both to the taxpayer and the Service of obtaining and then verifying the amount of every item in a mass of items is unreasonably high, for example, to determine the amount of sales under a revolving credit plan to be treated as deferred gross profit from sales on the installment plan under section 453 of the Code ( Rev. Proc. 64-4, 1964-1 (Part 1) C.B. 644, and Rev. Proc. 65-5, 1965-1 C.B. 720). Similarly, the acquiring corporation in a "B" reorganization may apply statistical sampling procedures to estimate the basis of all the shares acquired instead of surveying each shareholder.

The following sections of this revenue procedure set forth guidelines for estimating the basis of stock for which no basis is furnished by the former shareholder of the acquired corporation, and for using statistical sampling procedures instead of surveying 100 percent of the shareholders. The estimating procedure set forth in section 3 may be applicable in situations in which the acquiring corporation contacts all the former shareholders of the acquired corporation as well as in sampling situations, since nonresponses may be encountered in both situations. The guidelines set forth in section 4 may be applicable in situations where the burden of obtaining actual basis figures is unreasonable and the acquiring corporation is prepared to justify the use of statistical sampling techniques.

SEC. 3. GUIDELINES FOR ESTIMATING BASIS FOR NONRESPONSES

.01 When the acquiring corporation contacts all of its shareholders or contacts a sample of its shareholders in accordance with section 4 below, it may be unable to obtain the actual basis for some of the stock. For those shares of stock for which the exchanging shareholders of the acquired corporation do not furnish their basis, the acquiring corporation may estimate the basis from the best evidence available. The best evidence will generally be obtained from the stock transfer records of the acquired corporation. That is, for those exchanging shareholders who do not furnish to the acquiring corporation the basis for their stock in the acquired corporation, the basis at the time of the exchange may be estimated by (a) finding the date on which the stock certificate received from the shareholder was originally issued, (b) assuming all shares were acquired by purchase rather than by gift or inheritance, and (c) except as provided below, assigning to those shares as their basis the fair market value based on the mean trading price, determined from public quotations. An acceptable estimation procedure will be one for which the precision level at the 95 percent level of confidence (sampling error) does not exceed 10 percent of the point estimate of the basis. Documentation must be available, upon the district director's request, specifically describing the method used to estimate the basis, the method used to compute the sampling error, and the calculations validating that the 95 percent level of confidence at the 10 percent level of sampling error has been satisfied.

.02 For purpose of (c) above, the following exceptions will apply:

1 If on or about the date a stock certificate was issued to a shareholder, another certificate held by the same shareholder was cancelled, to the extent that the number of shares issued is less than or equal to the number of shares cancelled, the shares will not be valued at the date the new certificate was issued, but instead at the date of the earlier certificate. In turn, if this certificate was issued concurrent with the cancellation of another certificate the shares would be valued as of the date of the earliest issuance.

2 Stock acquired as a result of a tax-free stock split or stock dividend is assigned a zero basis.

3 For any stock acquired in a transaction the details of which are known to the corporation either directly or indirectly, the basis must be assigned based on all the information obtainable.

4 Stock exchanged in the reorganization that was received by the exchanging shareholder in an earlier tax-free exchange, will be assigned a zero basis, unless evidence is produced to support a higher basis.

5 The basis assigned to a share of stock must be reduced by cash dividend distributions paid to the exchanging shareholders by the acquired corporation that were tax free because they represented a return of capital (Section 301(c)(2) of the Code).

SEC. 4. SAMPLING GUIDELINES

.01 The sampling procedure designed and applied by the acquiring corporation must be in accordance with standard statistical methods, must be thoroughly documented, and must result in a probability sample. The documentation must be made available, upon request, to the district director with whom the acquiring corporation files its income tax returns.

.02 The sampling unit must be identified. One possible sampling unit would be a shareholder of the acquired corporation who participated in the reorganization exchange. The sampling procedure must define the frame, i.e., the population of elements that will be subjected to sampling. The frame must be constructed to accurately represent the entire population. The sampling procedure must document how the frame was constructed and identify what elements of the population make up the frame. The universe must be large enough so that standard statistical sampling methods may be used.

.03 An inquiry letter must be mailed to each of the sampling units of the acquired corporation who are selected for sampling, explaining the purpose for requesting the basis information for their surrendered stock, instructions on how to compute basis, and the importance of responding timely and accurately. Two follow-up letters should be sent at 30-day intervals to the sampling units who do not respond. In addition, several attempts should be made to telephone the sampling unit between the second and third letter inquiries. These telephone contacts should be attempted on different days of the week and times of the day. All results of attempted written and verbal contacts must be documented, and should be made immediately after the exchange of stock, if not before, to minimize nonresponses.

.04 The basis for shares of stock owned by sampling units that do not furnish their basis may be estimated under the guidelines set forth in section 3 of this revenue procedure.

.05 If upon examination, the district director is not satisfied that the acquiring corporation's sampling procedure utilizes standard statistical methods appropriately applied under the circumstances, or that the results obtained are accurate and reliable, within the standard set forth in section 3.01 of this revenue procedure, the corporation will be given the opportunity to recompute the estimate, expand the sample, or make other adjustments to the basis calculation. If for any reason the acquiring corporation does not eventually establish the basis to the satisfaction of the district director, then it will be determined whether the evidence presented by the acquiring corporation supports a basis in the acquired corporation's stock other than zero. The district director will not devise a statistical sampling procedure or recompute the acquiring corporation's statistical sampling estimate for this purpose.

SEC. 5. LIMITATIONS

The use of the estimating guidelines set forth in section 3 and the sampling guidelines set forth in section 4 are subject to the limitations of subsections 5.01 and 5.02 below.

.01 This revenue procedure is not to be construed as authorizing estimations or the use of statistical sampling methods to determine basis in every "B" reorganization. Upon examination, the taxpayer must be prepared to document the lack of shareholder response that justifies the use of estimates, and where applicable, be prepared to justify the use of statistical sampling techniques by showing that the burden of obtaining actual basis figures is unreasonable under the circumstances.

.02 Because of the unique facts that must be taken into account in designing a sampling procedure, the Service will not consider advance ruling requests or determination letters regarding the acceptability of a specific sampling procedure. For the same reason, advance ruling requests concerning estimation of the basis of stock will not be considered.

SEC. 6. EFFECT ON OTHER DOCUMENTS

This revenue procedure amplifies section 3.01 of Rev. Proc. 81-10, 1981-1 C.B. 647, to include the use of statistical sampling procedures and estimating procedures to determine basis in section 368(a)(1)(B) reorganizations among the no-rule areas.