SERVICE ANNOUNCES GUIDELINES FOR DEEMED ELECTIONS RELATING TO QUALIFIED STOCK/ASSET PURCHASES.

Rev. Proc. 89-40

SECTION 1. PURPOSE

This revenue procedure sets forth procedures under which a corporate taxpayer may request that the District Director impose a deemed election under section 338(e)(1) of the Internal Revenue Code and the temporary Income Tax Regulations (the "asset consistency rules") with respect to an asset acquisition that includes a qualified stock purchase of a target corporation.

SEC. 2. BACKGROUND

Pursuant to section 338(a) of the Code, if one corporation (the "target") is acquired by another corporation (the "purchasing corporation") in a qualified stock purchase, the purchasing corporation may elect under section 338(g) to have the target treated as if it (i) sold all of its assets in a single transaction at the close of the day on which the qualified stock purchase was completed (the "acquisition date"), and (ii) purchased those assets as a new corporation at the beginning of the following day for an amount generally equal to the price paid by the purchasing corporation for the stock of target, adjusted for target liabilities and other relevant items.

Section 338(e) of the Code contains asset consistency rules which are designed in general to prevent a purchasing corporation from selectively acquiring some assets from an affiliated group in a cost basis transaction while acquiring other assets and tax attributes from the same affiliated group in a carryover basis transaction (i.e., through a stock acquisition not involving a section 338 election). Where a purchasing corporation acquires a target corporation in a qualified stock purchase and also acquires an asset from the target or a target affiliate during the target's consistency period, section 338(e)(1) generally deems the purchasing corporation to have made a section 338 election (a "deemed election") with respect to the purchase of the target stock.

Section 338(e)(2) of the Code contains several exceptions to the deemed election rule. Specifically, section 338(e)(2)(D) authorizes the Secretary to prescribe regulations that describe transactions where section 338(e)(1) does not cause a deemed election. Under the temporary regulations, if a corporation acquires a target in a qualified stock purchase and acquires an asset from the target or a target affiliate during the target's consistency period without making an express section 338 election for the target, then the corporation generally will not obtain a cost basis in any asset acquired from the target (or a target affiliate). Instead, a "tainted asset acquisition" generally will occur. This acquisition causes a carryover basis election by affirmative action ("affirmative action carryover election") unless a protective carryover election is made under section 1.338-4T(f)(6)(i)(A) of the temporary regulations. In the event of either a protective carryover election or an affirmative action carryover election, the purchasing corporation obtains a basis in the asset so acquired equal to the adjusted basis of that asset in the hands of the selling corporation immediately before the transfer.

Where a corporation purchases assets from an unrelated corporation, a qualified stock purchase may occur inadvertently because the purchasing corporation is unaware that the assets purchased include the stock of a subsidiary or does not recognize the significance of such an acquisition. If either an express section 338 election or a protective carryover election is not made, this acquisition will cause an affirmative action carryover election irrespective of the value of the stock acquired. There is no exception under the temporary regulations from the affirmative action carryover election where the value of the target stock acquired is de minimis in relation to the value of all of the assets acquired in the acquisition. Compare section 1.338-4T(f)(7) of the temporary regulations (which provides an exception from the deemed election under section 338(e)(1) of the Code for de minimis asset acquisitions).

The consequences of an affirmative action carryover election, however, may be avoided if the District Director imposes a deemed election under section 338(e)(1) of the Code. The District Director will impose a deemed election only if the District Director determines that imposing the deemed election is appropriate to carry out the purposes of the section 338 consistency rules. See section 1.338-4T(f)(1)(ii) Question and Answer 1 of the temporary regulations.

SEC. 3. PROCEDURE FOR SEEKING APPLICATION OF SECTION 338(e)(1)

01 REQUEST FOR A DEEMED ELECTION UNDER SECTION 338(e)(1).

A taxpayer may request under this revenue procedure that a deemed election under section 338(e)(1) of the Code be imposed by the District Director. Generally, the District Director will impose a deemed election under that section only in connection with the examination of a federal income tax return that would be affected by the deemed election. However, if the taxpayer requests under this revenue procedure that a deemed election be imposed and the District Director's decision in this matter would affect the position taken by the taxpayer in filing an initial or amended income tax return, the District Director will consider and respond to such a request normally within 90 days. The fact that a District Director does not respond favorably to such a request, however, does not preclude the District Director from subsequently imposing a deemed section 338(e)(1) election.

If a favorable response is made to a taxpayer's request for the imposition of a deemed election under this revenue procedure, this response will constitute a final determination that will not be changed or revoked by the Service, provided that the taxpayer neither misstated nor omitted any material fact in the request. However, the issuance or nonissuance of such a determination does not constitute an audit, does not prevent or limit a subsequent audit of the taxpayer for any tax year, and in no way changes or alters the Service's other examination activity with respect to the taxpayer.

02 AUTHORITY OF DISTRICT DIRECTOR. Except for the mandatory relief under section 3.03, whether a deemed election should be imposed is a determination made solely by the District Director taking into consideration whatever factors the District Director finds relevant.

03 DE MINIMIS STOCK ACQUISITION. Upon request by the taxpayer, the District Director will impose a deemed election if:

(i) The aggregate gross fair market value on the acquisition date of all the assets of target with respect to which there is a qualified stock purchase is less than or equal to the greater of (A) 10 percent of the aggregate gross fair market value of all the assets (including target stock) purchased from the selling corporation on the date(s) the assets were purchased, or (B) $200,000;

(ii) The statute of limitations has not expired with respect to any of the affected tax years, as defined in section 1.338- 1T(m)(12)(i) of the temporary regulations, or, if the statute of limitations has expired with respect to an affected year, granting relief will not prejudice the interests of the Service; and

(iii) The taxpayer represents that the request for the deemed election results solely from taxpayer's inadvertent failure to realize that it had made a tainted asset acquisition that results in an affirmative action carryover election.

04 REQUIREMENTS FOR A REQUEST. Except as specifically provided in this revenue procedure, a request for imposition of a deemed election under section 338(e)(1) of the Code should comply with the requirements for a request for a determination letter (see section 8 of Rev. Proc. 89-1, 1989-1 I.R.B. 8, 13-17). The request must be:

(i) Submitted to the District Director (Attention: Chief of Examination) for the internal revenue district to which an election under section 338 would have been submitted (see section 1.338- 1T(c)(1)(ii) of the temporary regulations):

(ii) Entitled Relief Request for a Deemed Election Under Section 338(e)(1) of the Internal Revenue Code; and

(iii) Submitted with the information described in sections 3.05- 3.09 below.

05 AUDIT JURISDICTION. The request must:

(i) Indicate whether the tax year of the purchasing corporation that includes the acquisition date, as well as each tax year of each corporation that would be affected by a deemed election for target, is open for assessment of additional tax;

(ii) Indicate with respect to each such year the name of the District Office having audit jurisdiction and the approximate date that the return for each year was filed; and

(iii) Provide a complete copy of all agreements with the Commissioner extending the statute of limitations for assessment of tax for any of these tax years for any of these corporations.

06 OTHER SECTION 338 ELECTIONS. The request must state whether, with regard to the qualified stock purchase, the purchasing corporation or any member of the affiliated group, as defined in section 338(h)(5) of the Code, of which the purchasing corporation is a member, made or attempted to make an express election under section 338(g) of the Code or a protective carryover election under section 1.338-4T(f)(6)(i)(A) of the temporary regulations.

07 QUALIFIED STOCK PURCHASE. The request must provide information demonstrating that the stock purchase constituted a qualified stock purchase, within the meaning of section 338(d)(3) of the Code, by the purchasing corporation. Such information should include the total number of shares of each class of target corporation stock outstanding and the number of such shares acquired by the purchasing corporation. The request must also state the date of each asset purchase and stock purchase by the purchasing corporation.

08 SELLING CORPORATION A TARGET AFFILIATE. The request must provide information demonstrating that the selling corporation was a target affiliate within the meaning of section 338(h)(6) of the Code and the regulations thereunder. Such information should include the ownership interest of the selling corporation in target immediately prior to the qualified stock purchase.

09 VALUE OF TARGET ASSETS. The request must state the approximate aggregate gross fair market value of (i) all the assets (including target stock) purchased from the selling corporation on the date(s) the assets were purchased, and (ii) all the assets held by target on the acquisition date. For this purpose, the "aggregate gross fair market value" of these assets is the sum of the fair market values of all the assets without regard to liabilities.

SEC. 4. COMMENTS OR INQUIRIES

Comments or inquiries regarding this revenue procedure should be addressed to the associate Chief Counsel (Technical), Attention C:CORP:5 Internal Revenue Service, 1111 Constitution Ave., N.W., Washington, D.C. 20224.

SEC. 5. EFFECTIVE DATE

This revenue procedure is effective for requests filed after July 3, 1989.

DRAFTING INFORMATION

The principal author of this revenue procedure is Michael Danbury of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue procedure, contact Keith Medieau on (202) 566-3551 (not a toll-free call).