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PROVISIONS of the INTERNAL REVENUE CODE andTREASURY REGULATIONS

Table Of Contents

Section 267 p. 2

Section 301 p. 3

Section 302 p. 4

Section 311 p. 10

Section 316 p. 11

Section 317 p. 12

Section 318 p. 13

Section 331 p. 17

Section 334 p. 18

Section 336 p. 19

Section 351 p. 22

Section 354 p. 24

Section 355 p. 25

Section 356 p. 30

Section 361 p. 35

Section 362 p. 37

Section 368 p. 38

Section 1032 p. 42

Reg. 1.355-2 p. 43

Reg. 1.355-3 p. 58

Reg. 1.368-2(j) p. 65

Rev. Proc. 77-37 p. 69

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Sec. 267 Losses, expenses, and interest with respect to transactions

between related taxpayers

(a) In general

(1) Deduction for losses disallowed

No deduction shall be allowed in respect of any loss from the sale or exchange ofproperty, directly or indirectly, between persons specified in any of the paragraphs ofsubsection (b). The preceding sentence shall not apply to any loss of the distributingcorporation (or the distributee) in the case of a distribution in complete liquidation.

(b) Relationships

The persons referred to in subsection (a) are:

(2) An individual and a corporation more than 50 percent in value of the

outstanding stock of which is owned, directly or indirectly, by or for such individual;

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Sec. 301Distributions of property

(a) In general

Except as otherwise provided in this chapter, a distribution of property (asdefined in section 317(a)) made by a corporation to a shareholder withrespect to its stock shall be treated in the manner provided in subsection (c).

(b) Amount distributed

(1) General rule

For purposes of this section, the amount of any distribution shall bethe amount of money received, plus the fair market value of the otherproperty received.

(c) Amount taxable

In the case of a distribution to which subsection (a) applies--

(1) Amount constituting dividend

That portion of the distribution which is a dividend (as defined insection 316) shall be included in gross income.

(2) Amount applied against basis

That portion of the distribution which is not a dividend shall beapplied against and reduce the adjusted basis of the stock.

(3) Amount in excess of basis

(A) In general

Except as provided in subparagraph (B), that portion of thedistribution which is not a dividend, to the extent that it exceedsthe adjusted basis of the stock, shall be treated as gain from the

sale or exchange of property.

(d) Basis

The basis of property received in a distribution to which subsection (a)applies shall be the fair market value of such property.

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Sec. 302Distributions in redemption of stock

(a) General rule

If a corporation redeems its stock (within the meaning of section 317(b)),and if paragraph (1), (2), (3), or (4) of subsection (b) applies, suchredemption shall be treated as a distribution in part or full payment inexchange for the stock.

(b) Redemptions treated as exchanges

(1) Redemptions not equivalent to dividends

Subsection (a) shall apply if the redemption is not essentiallyequivalent to a dividend.

(2) Substantially disproportionate redemption of stock

(A) In general

Subsection (a) shall apply if the distribution is substantiallydisproportionate with respect to the shareholder.

(B) Limitation

This paragraph shall not apply unless immediately after the

redemption the shareholder owns less than 50 percent of thetotal combined voting power of all classes of stock entitled tovote.

(C) Definitions

For purposes of this paragraph, the distribution issubstantially disproportionate if--

(i) the ratio which the voting stock of the corporationowned by the shareholder immediately after the

redemption bears to all of the voting stock of thecorporation at such time,

is less than 80 percent of--

(ii) the ratio which the voting stock of the corporationowned by the shareholder immediately before the

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redemption bears to all of the voting stock of thecorporation at such time.

For purposes of this paragraph, no distribution shall be treated assubstantially disproportionate unless the shareholder's

ownership of the common stock of the corporation (whethervoting or nonvoting) after and before redemption also meets the80 percent requirement of the preceding sentence. For purposesof the preceding sentence, if there is more than one class ofcommon stock, the determinations shall be made by reference tofair market value.

(3) Termination of shareholder's interest

Subsection (a) shall apply if the redemption is in completeredemption of all of the stock of the corporation owned by the

shareholder.

(4) Redemption from noncorporate shareholder in partial liquidation

Subsection (a) shall apply to a distribution if such distribution is--

(A) in redemption of stock held by a shareholder who is not acorporation, and

(B) in partial liquidation of the distributing corporation.

(5) Application of paragraphs

In determining whether a redemption meets the requirements ofparagraph (1), the fact that such redemption fails to meet therequirements of paragraph (2), (3), or (4) shall not be taken intoaccount. If a redemption meets the requirements of paragraph (3) andalso the requirements of paragraph (1), (2), or (4), then so much ofsubsection (c)(2) as would (but for this sentence) apply in respect ofthe acquisition of an interest in the corporation within the 10-yearperiod beginning on the date of the distribution shall not apply.

(c) Constructive ownership of stock

(1) In general

Except as provided in paragraph (2) of this subsection, section318(a) shall apply in determining the ownership of stock for purposesof this section.

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(2) For determining termination of interest

(A) In the case of a distribution described in subsection (b)(3),section 318(a)(1) shall not apply if--

(i) immediately after the distribution the distributee has no

interest in the corporation (including an interest as officer,director, or employee), other than an interest as a creditor,

(ii) the distributee does not acquire any such interest(other than stock acquired by bequest or inheritance)within 10 years from the date of such distribution, and

(iii) the distributee, at such time and in such manner as theSecretary by regulations prescribes, files an agreement tonotify the Secretary of any acquisition described in clause(ii) and to retain such records as may be necessary for the

application of this paragraph.

If the distributee acquires such an interest in the corporation(other than by bequest or inheritance) within 10 years from thedate of the distribution, then the periods of limitation provided insections 6501 and 6502 on the making of an assessment and thecollection by levy or a proceeding in court shall, with respect toany deficiency (including interest and additions to the tax)resulting from such acquisition, include one year immediatelyfollowing the date on which the distributee (in accordance withregulations prescribed by the Secretary) notifies the Secretary of

such acquisition; and such assessment and collection may bemade notwithstanding any provision of law or rule of law whichotherwise would prevent such assessment and collection.

(B) Subparagraph (A) of this paragraph shall not apply if--

(i) any portion of the stock redeemed was acquired,directly or indirectly, within the 10-year period ending onthe date of the distribution by the distributee from aperson the ownership of whose stock would (at the time ofdistribution) be attributable to the distributee under

section 318(a), or

(ii) any person owns (at the time of the distribution) stockthe ownership of which is attributable to the distributeeunder section 318(a) and such person acquired any stockin the corporation, directly or indirectly, from thedistributee within the 10-year period ending on the date of

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the distribution, unless such stock so acquired from thedistributee is redeemed in the same transaction.

The preceding sentence shall not apply if the acquisition (or, inthe case of clause (ii), the disposition) by the distributee did not

have as one of its principal purposes the avoidance of Federalincome tax.

(C) Special rule for waivers by entities

(i) In general

Subparagraph (A) shall not apply to a distribution to anyentity unless--

(I) such entity and each related person meet the

requirements of clauses (i), (ii), and (iii) ofsubparagraph (A), and

(II) each related person agrees to be jointly andseverally liable for any deficiency (including interestand additions to tax) resulting from an acquisitiondescribed in clause (ii) of subparagraph (A).

In any case to which the preceding sentence applies, thesecond sentence of subparagraph (A) and subparagraph(B)(ii) shall be applied by substituting "distributee or any

related person" for "distributee" each place it appears.

(ii) Definitions

For purposes of this subparagraph--

(I) the term "entity" means a partnership, estate,trust, or corporation; and

(II) the term "related person" means any person towhom ownership of stock in the corporation is (at the

time of the distribution) attributable under section318(a)(1) if such stock is further attributable to theentity under section 318(a)(3).

(d) Redemptions treated as distributions of property

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Except as otherwise provided in this subchapter, if a corporation redeemsits stock (within the meaning of section 317(b)), and if subsection (a) of thissection does not apply, such redemption shall be treated as a distribution ofproperty to which section 301 applies.

(e) Partial liquidation defined

(1) In general

For purposes of subsection (b)(4), a distribution shall be treated asin partial liquidation of a corporation if--

(A) the distribution is not essentially equivalent to a dividend(determined at the corporate level rather than at the shareholderlevel), and

(B) the distribution is pursuant to a plan and occurs within thetaxable year in which the plan is adopted or within thesucceeding taxable year.

(2) Termination of business

The distributions which meet the requirements of paragraph (1)(A)shall include (but shall not be limited to) a distribution which meets therequirements of subparagraphs (A) and (B) of this paragraph:

(A) The distribution is attributable to the distributing

corporation's ceasing to conduct, or consists of the assets of, aqualified trade or business.

(B) Immediately after the distribution, the distributingcorporation is actively engaged in the conduct of a qualifiedtrade or business.

(3) Qualified trade or business

For purposes of paragraph (2), the term "qualified trade orbusiness" means any trade or business which--

(A) was actively conducted throughout the 5-year period endingon the date of the redemption, and

(B) was not acquired by the corporation within such period in atransaction in which gain or loss was recognized in whole or inpart.

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(4) Redemption may be pro rata

Whether or not a redemption meets the requirements ofsubparagraphs (A) and (B) of paragraph (2) shall be determinedwithout regard to whether or not the redemption is pro rata with

respect to all of the shareholders of the corporation.

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Sec. 311Taxability of corporation on distribution

(a) General rule

Except as provided in subsection (b), no gain or loss shall be recognized

to a corporation on the distribution (not in complete liquidation) with respectto its stock of--

(1) its stock (or rights to acquire its stock), or

(2) property.

(b) Distributions of appreciated property

(1) In general

If--

(A) a corporation distributes property (other than an obligation ofsuch corporation) to a shareholder in a distribution to whichsubpart A applies, and

(B) the fair market value of such property exceeds its adjustedbasis (in the hands of the distributing corporation),

then gain shall be recognized to the distributing corporation as if suchproperty were sold to the distributee at its fair market value.

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Sec. 316Dividend defined

(a) General rule

For purposes of this subtitle, the term "dividend" means any distributionof property made by a corporation to its shareholders--

(1) out of its earnings and profits accumulated after February 28, 1913,or

(2) out of its earnings and profits of the taxable year (computed as ofthe close of the taxable year without diminution by reason of anydistributions made during the taxable year), without regard to theamount of the earnings and profits at the time the distribution wasmade.

Except as otherwise provided in this subtitle, every distribution is made outof earnings and profits to the extent thereof, and from the most recentlyaccumulated earnings and profits. To the extent that any distribution is,under any provision of this subchapter, treated as a distribution of propertyto which section 301 applies, such distribution shall be treated as adistribution of property for purposes of this subsection.

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Sec. 317Other definitions

(a) Property

For purposes of this part, the term "property" means money, securities,and any other property; except that such term does not include stock in thecorporation making the distribution (or rights to acquire such stock).

(b) Redemption of stock

For purposes of this part, stock shall be treated as redeemed by acorporation if the corporation acquires its stock from a shareholder inexchange for property, whether or not the stock so acquired is cancelled,retired, or held as treasury stock.

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Sec. 318Constructive ownership of stock

(a) General rule

For purposes of those provisions of this subchapter to which the rulescontained in this section are expressly made applicable--

(1) Members of family

(A) In general

An individual shall be considered as owning the stock owned,directly or indirectly, by or for--

(i) his spouse (other than a spouse who is legally separated

from the individual under a decree of divorce or separatemaintenance), and

(ii) his children, grandchildren, and parents.

(B) Effect of adoption

For purposes of subparagraph (A)(ii), a legally adopted childof an individual shall be treated as a child of such individual byblood.

(2) Attribution from partnerships, estates, trusts, and corporations

(A) From partnerships and estates

Stock owned, directly or indirectly, by or for a partnership orestate shall be considered as owned proportionately by itspartners or beneficiaries.

(B) From trusts

(i) Stock owned, directly or indirectly, by or for a trust

(other than an employees' trust described in section 401(a)which is exempt from tax under section 501(a)) shall beconsidered as owned by its beneficiaries in proportion tothe actuarial interest of such beneficiaries in such trust.

(ii) Stock owned, directly or indirectly, by or for any portionof a trust of which a person is considered the owner under

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subpart E of part I of subchapter J (relating to grantors andothers treated as substantial owners) shall be consideredas owned by such person.

(C) From corporations

If 50 percent or more in value of the stock in a corporation isowned, directly or indirectly, by or for any person, such personshall be considered as owning the stock owned, directly orindirectly, by or for such corporation, in that proportion which thevalue of the stock which such person so owns bears to the valueof all the stock in such corporation.

(3) Attribution to partnerships, estates, trusts, and corporations

(A) To partnerships and estates

Stock owned, directly or indirectly, by or for a partner or abeneficiary of an estate shall be considered as owned by thepartnership or estate.

(B) To trusts

(i) Stock owned, directly or indirectly, by or for abeneficiary of a trust (other than an employees' trustdescribed in section 401(a) which is exempt from tax undersection 501(a)) shall be considered as owned by the trust,

unless such beneficiary's interest in the trust is a remotecontingent interest. For purposes of this clause, acontingent interest of a beneficiary in a trust shall beconsidered remote if, under the maximum exercise ofdiscretion by the trustee in favor of such beneficiary, thevalue of such interest, computed actuarially, is 5 percent orless of the value of the trust property.

(ii) Stock owned, directly or indirectly, by or for a personwho is considered the owner of any portion of a trust undersubpart E of part I of subchapter J (relating to grantors and

others treated as substantial owners), shall be consideredas owned by the trust.

(C) To corporations

If 50 percent or more in value of the stock in a corporation isowned, directly or indirectly, by or for any person, such

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corporation shall be considered as owning the stock owned,directly or indirectly, by or for such person.

(4) Options

If any person has an option to acquire stock, such stock shall beconsidered as owned by such person. For purposes of this paragraph,an option to acquire such an option, and each one of a series of suchoptions, shall be considered as an option to acquire such stock.

(5) Operating rules

(A) In general

Except as provided in subparagraphs (B) and (C), stock

constructively owned by a person by reason of the application ofparagraph (1), (2), (3), or (4), shall, for purposes of applyingparagraphs (1), (2), (3), and (4), be considered as actually ownedby such person.

(B) Members of family

Stock constructively owned by an individual by reason of theapplication of paragraph (1) shall not be considered as owned byhim for purposes of again applying paragraph (1) in order tomake another the constructive owner of such stock.

(C) Partnerships, estates, trusts, and corporations

Stock constructively owned by a partnership, estate, trust, orcorporation by reason of the application of paragraph (3) shallnot be considered as owned by it for purposes of applyingparagraph (2) in order to make another the constructive owner ofsuch stock.

(D) Option rule in lieu of family rule

For purposes of this paragraph, if stock may be considered asowned by an individual under paragraph (1) or (4), it shall beconsidered as owned by him under paragraph (4).

(E) S corporation treated as partnership

For purposes of this subsection--

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(i) an S corporation shall be treated as a partnership, and

(ii) any shareholder of the S corporation shall be treated asa partner of such partnership.

The preceding sentence shall not apply for purposes ofdetermining whether stock in the S corporation is constructivelyowned by any person.

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Sec. 331Gain or loss to shareholders in corporate liquidations

(a) Distributions in complete liquidation treated as exchanges

Amounts received by a shareholder in a distribution in completeliquidation of a corporation shall be treated as in full payment in exchangefor the stock.

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Sec. 334Basis of property received in liquidations

(a) General rule

If property is received in a distribution in complete liquidation, and if gainor loss is recognized on receipt of such property, then the basis of theproperty in the hands of the distributee shall be the fair market value of suchproperty at the time of the distribution.

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Sec. 336Gain or loss recognized on property distributed in

complete liquidation

(a) General rule

Except as otherwise provided in this section or section 337, gain or lossshall be recognized to a liquidating corporation on the distribution ofproperty in complete liquidation as if such property were sold to thedistributee at its fair market value.

(b) Treatment of liabilities

If any property distributed in the liquidation is subject to a liability or theshareholder assumes a liability of the liquidating corporation in connection

with the distribution, for purposes of subsection (a) and section 337, the fairmarket value of such property shall be treated as not less than the amountof such liability.

(c) Exception for liquidations which are part of a reorganization

For provision providing that this subpart does not apply to distributions inpursuance of a plan of reorganization, see section 361(c)(4).

(d) Limitations on recognition of loss

(1) No loss recognized in certain distributions to related persons

(A) In general

No loss shall be recognized to a liquidating corporation on thedistribution of any property to a related person (within themeaning of section 267) if--

(i) such distribution is not pro rata, or

(ii) such property is disqualified property.

(B) Disqualified property

For purposes of subparagraph (A), the term "disqualifiedproperty" means any property which is acquired by theliquidating corporation in a transaction to which section 351applied, or as a contribution to capital, during the 5-year period

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ending on the date of the distribution. Such term includes anyproperty if the adjusted basis of such property is determined (inwhole or in part) by reference to the adjusted basis of propertydescribed in the preceding sentence.

(2) Special rule for certain property acquired in certain carryover basistransactions

(A) In general

For purposes of determining the amount of loss recognized byany liquidating corporation on any sale, exchange, or distributionof property described in subparagraph (B), the adjusted basis ofsuch property shall be reduced (but not below zero) by theexcess (if any) of--

(i) the adjusted basis of such property immediately after itsacquisition by such corporation, over

(ii) the fair market value of such property as of such time.

(B) Description of property

(i) In general

For purposes of subparagraph (A), property is describedin this subparagraph if--

(I) such property is acquired by the liquidatingcorporation in a transaction to which section 351applied or as a contribution to capital, and

(II) the acquisition of such property by the liquidatingcorporation was part of a plan a principal purpose ofwhich was to recognize loss by the liquidatingcorporation with respect to such property inconnection with the liquidation.

Other property shall be treated as so described if theadjusted basis of such other property is determined (inwhole or in part) by reference to the adjusted basis ofproperty described in the preceding sentence.

(ii) Certain acquisitions treated as part of plan

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For purposes of clause (i), any property described inclause (i)(I) acquired by the liquidated corporation after thedate 2 years before the date of the adoption of the plan ofcomplete liquidation shall, except as provided inregulations, be treated as acquired as part of a plan

described in clause (i)(II).

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Sec. 351Transfer to corporation controlled by transferor

(a) General rule

No gain or loss shall be recognized if property is transferred to acorporation by one or more persons solely in exchange for stock in suchcorporation and immediately after the exchange such person or persons arein control (as defined in section 368(c)) of the corporation.

(b) Receipt of property

If subsection (a) would apply to an exchange but for the fact that there isreceived, in addition to the stock permitted to be received under subsection

(a), other property or money, then--

(1) gain (if any) to such recipient shall be recognized, but not in excessof--

(A) the amount of money received, plus

(B) the fair market value of such other property received; and

(2) no loss to such recipient shall be recognized.

(c) Special rules where distribution to shareholders

(1) In general

In determining control for purposes of this section, the fact that anycorporate transferor distributes part or all of the stock in thecorporation which it receives in the exchange to its shareholders shallnot be taken into account.

(2) Special rule for section 355

If the requirements of section 355 (or so much of section 356 asrelates to section 355) are met with respect to a distribution describedin paragraph (1), then, solely for purposes of determining the taxtreatment of the transfers of property to the controlled corporation bythe distributing corporation, the fact that the shareholders of thedistributing corporation dispose of part or all of the distributed stock,

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or the fact that the corporation whose stock was distributed issuesadditional stock, shall not be taken into account in determining controlfor purposes of this section.

(d) Services, certain indebtedness, and accrued interest not treated asproperty

For purposes of this section, stock issued for--

(1) services,

(2) indebtedness of the transferee corporation which is not evidencedby a security, or

(3) interest on indebtedness of the transferee corporation which

accrued on or after the beginning of the transferor's holding period forthe debt,

shall not be considered as issued in return for property.

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Sec. 354Exchanges of stock and securities in certain

reorganizations

(a) General rule

(1) In general

No gain or loss shall be recognized if stock or securities in acorporation a party to a reorganization are, in pursuance of the plan ofreorganization, exchanged solely for stock or securities in suchcorporation or in another corporation a party to the reorganization.

(2) Limitations

(A) Excess principal amount

Paragraph (1) shall not apply if--

(i) the principal amount of any such securities receivedexceeds the principal amount of any such securitiessurrendered, or

(ii) any such securities are received and no such securitiesare surrendered.

(b) Exception

(1) In general

Subsection (a) shall not apply to an exchange in pursuance of aplan of reorganization within the meaning of subparagraph (D) or (G) ofsection 368(a)(1), unless--

(A) the corporation to which the assets are transferredacquires substantially all of the assets of the transferor ofsuch assets

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Sec. 355Distribution of stock and securities of a controlled

corporation

(a) Effect on distributees

(1) General rule

If

(A) a corporation (referred to in this section as the "distributingcorporation")--

(i) distributes to a shareholder, with respect to its stock, or

(ii) distributes to a security holder, in exchange for itssecurities,

solely stock or securities of a corporation (referred to in thissection as "controlled corporation") which it controls immediatelybefore the distribution,

(B) the transaction was not used principally as a device for the

distribution of the earnings and profits of the distributingcorporation or the controlled corporation or both (but the merefact that subsequent to the distribution stock or securities in oneor more of such corporations are sold or exchanged by all orsome of the distributees (other than pursuant to an arrangementnegotiated or agreed upon prior to such distribution) shall not beconstrued to mean that the transaction was used principally assuch a device),

(C) the requirements of subsection (b) (relating to activebusinesses) are satisfied, and

(D) as part of the distribution, the distributing corporationdistributes--

(i) all of the stock and securities in the controlledcorporation held by it immediately before the distribution,or

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(ii) an amount of stock in the controlled corporationconstituting control within the meaning of section 368(c),and it is established to the satisfaction of the Secretarythat the retention by the distributing corporation of stock(or stock and securities) in the controlled corporation was

not in pursuance of a plan having as one of its principalpurposes the avoidance of Federal income tax,

then no gain or loss shall be recognized to (and no amount shallbe includible in the income of) such shareholder or securityholder on the receipt of such stock or securities.

(2) Non pro rata distributions, etc.

Paragraph (1) shall be applied without regard to the following:

(A) whether or not the distribution is pro rata with respect to allof the shareholders of the distributing corporation,

(B) whether or not the shareholder surrenders stock in thedistributing corporation, and

(C) whether or not the distribution is in pursuance of a plan ofreorganization (within the meaning of section 368(a)(1)(D)).

(3) Limitations

(A) Excess principal amount

Paragraph (1) shall not apply if--

(i) the principal amount of the securities in the controlledcorporation which are received exceeds the principalamount of the securities which are surrendered inconnection with such distribution, or

(ii) securities in the controlled corporation are received andno securities are surrendered in connection with such

distribution.

(B) Stock acquired in taxable transactions within 5 years treatedas boot

For purposes of this section (other than paragraph (1)(D) ofthis subsection) and so much of section 356 as relates to this

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section, stock of a controlled corporation acquired by thedistributing corporation by reason of any transaction--

(i) which occurs within 5 years of the distribution of suchstock, and

(ii) in which gain or loss was recognized in whole or in part,

shall not be treated as stock of such controlled corporation, butas other property.

(b) Requirements as to active business

(1) In general

Subsection (a) shall apply only if either--

(A) the distributing corporation, and the controlled corporation(or, if stock of more than one controlled corporation isdistributed, each of such corporations), is engaged immediatelyafter the distribution in the active conduct of a trade or business,or

(B) immediately before the distribution, the distributingcorporation had no assets other than stock or securities in thecontrolled corporations and each of the controlled corporations isengaged immediately after the distribution in the active conduct

of a trade or business.

(2) Definition

For purposes of paragraph (1), a corporation shall be treated asengaged in the active conduct of a trade or business if and only if--

(A) it is engaged in the active conduct of a trade or business, orsubstantially all of its assets consist of stock and securities of acorporation controlled by it (immediately after the distribution)which is so engaged,

(B) such trade or business has been actively conductedthroughout the 5-year period ending on the date of thedistribution,

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(ii) the fair market value of such property exceeds itsadjusted basis (in the hands of the distributingcorporation),

then gain shall be recognized to the distributing corporation as if

such property were sold to the distributee at its fair marketvalue.

(B) Qualified property

For purposes of subparagraph (A), the term "qualifiedproperty" means any stock or securities in the controlledcorporation.

(3) Coordination with sections 311 and 336(a)

Sections 311 and 336(a) shall not apply to any distribution referredto in paragraph (1).

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Sec. 356Receipt of additional consideration

(a) Gain on exchanges

(1) Recognition of gain

If--

(A) section 354 or 355 would apply to an exchange but for thefact that

(B) the property received in the exchange consists not only ofproperty permitted by section 354 or 355 to be received withoutthe recognition of gain but also of other property or money,

then the gain, if any, to the recipient shall be recognized, but in anamount not in excess of the sum of such money and the fair marketvalue of such other property.

(2) Treatment as dividend

If an exchange is described in paragraph (1) but has the effect ofthe distribution of a dividend (determined with the application ofsection 318(a)), then there shall be treated as a dividend to eachdistributee such an amount of the gain recognized under paragraph (1)as is not in excess of his ratable share of the undistributed earnings

and profits of the corporation accumulated after February 28, 1913.The remainder, if any, of the gain recognized under paragraph (1) shallbe treated as gain from the exchange of property.

(b) Additional consideration received in certain distributions

If--

(1) section 355 would apply to a distribution but for the fact that

(2) the property received in the distribution consists not only ofproperty permitted by section 355 to be received without therecognition of gain, but also of other property or money,

then an amount equal to the sum of such money and the fair market value ofsuch other property1

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shall be treated as a distribution of property to which section 301 applies.

(c) Loss

If--

(1) section 354 would apply to an exchange or section 355 would applyto an exchange or distribution, but for the fact that

(2) the property received in the exchange or distribution consists notonly of property permitted by section 354 or 355 to be receivedwithout the recognition of gain or loss, but also of other property ormoney,

then no loss from the exchange or distribution shall be recognized.

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Sec. 357Assumption of liability

(a) General rule

Except as provided in subsections (b) and (c), if--

(1) the taxpayer receives property which would be permitted to bereceived under section 351 or 361, without the recognition of gain if itwere the sole consideration, and

(2) as part of the consideration, another party to the exchangeassumes a liability of the taxpayer,

then such assumption shall not be treated as money or other property, andshall not prevent the exchange from being within the provisions of section351 or 361, as the case may be.

(b) Tax avoidance purpose

(1) In general

If, taking into consideration the nature of the liability and thecircumstances in the light of which the arrangement for the

assumption was made, it appears that the principal purpose of thetaxpayer with respect to the assumption described in subsection (a)--

(A) was a purpose to avoid Federal income tax on the exchange,or

(B) if not such purpose, was not a bona fide business purpose,

then such assumption (in the total amount of the liability assumed

pursuant to such exchange) shall, for purposes of section 351 or 361,(as the case may be), be considered as money received by thetaxpayer on the exchange.

(2) Burden of proof

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In any suit or proceeding where the burden is on the taxpayer toprove such assumption or acquisition is not to be treated as moneyreceived by the taxpayer, such burden shall not be considered assustained unless the taxpayer sustains such burden by the clearpreponderance of the evidence.

(c) Liabilities in excess of basis

(1) In general

In the case of an exchange--

(A) to which section 351 applies, or

(B) to which section 361 applies by reason of a plan ofreorganization within the meaning of section 368(a)(1)(D) withrespect to which stock or securities of the corporation to whichthe assets are transferred are distributed in a transaction whichqualifies under section 355,

if the sum of the amount of the liabilities assumed exceeds the totalof the adjusted basis of the property transferred pursuant to suchexchange, then such excess shall be considered as a gain from thesale or exchange of a capital asset or of property which is not a capital

asset, as the case may be.

(2) Exceptions

Paragraph (1) shall not apply to any exchange--

(A) to which subsection (b)(1) of this section applies, or

(B) which is pursuant to a plan of reorganization within themeaning of section 368(a)(1)(G) where no former shareholder of

the transferor corporation receives any consideration for hisstock.

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Sec. 358Basis to distributees

(a) General rule

In the case of an exchange to which section 351, 354, 355, 356, or 361,applies--

(1) Nonrecognition property

The basis of the property permitted to be received under suchsection without the recognition of gain or loss shall be the same as thatof the property exchanged--

(A) decreased by--

(i) the fair market value of any other property (exceptmoney) received by the taxpayer,

(ii) the amount of any money received by the taxpayer,and

(iii) the amount of loss to the taxpayer which wasrecognized on such exchange, and

(B) increased by--

(i) the amount which was treated as a dividend, and

(ii) the amount of gain to the taxpayer which wasrecognized on such exchange (not including any portion ofsuch gain which was treated as a dividend).

(2) Other property

The basis of any other property (except money) received by thetaxpayer shall be its fair market value.

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Sec. 361Nonrecognition of gain or loss to corporations;

treatment of distributions

(a) General rule

No gain or loss shall be recognized to a corporation if such corporation isa party to a reorganization and exchanges property, in pursuance of the planof reorganization, solely for stock or securities in another corporation a partyto the reorganization.

(b) Exchanges not solely in kind

(1) Gain

If subsection (a) would apply to an exchange but for the fact thatthe property received in exchange consists not only of stock orsecurities permitted by subsection (a) to be received without therecognition of gain, but also of other property or money, then--

(A) Property distributed

If the corporation receiving such other property or money

distributes it in pursuance of the plan of reorganization, no gainto the corporation shall be recognized from the exchange, but

(B) Property not distributed

If the corporation receiving such other property or moneydoes not distribute it in pursuance of the plan of reorganization,the gain, if any, to the corporation shall be recognized.

The amount of gain recognized under subparagraph (B) shall not

exceed the sum of the money and the fair market value of the otherproperty so received which is not so distributed.

(2) Loss

If subsection (a) would apply to an exchange but for the fact thatthe property received in exchange consists not only of property

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permitted by subsection (a) to be received without the recognition ofgain or loss, but also of other property or money, then no loss from theexchange shall be recognized.

(c) Treatment of distributions

(1) In general

Except as provided in paragraph (2), no gain or loss shall berecognized to a corporation a party to a reorganization on thedistribution to its shareholders of property in pursuance of the plan ofreorganization.

(2) Distributions of appreciated property

(A) In general

If--

(i) in a distribution referred to in paragraph (1), thecorporation distributes property other than qualifiedproperty, and

(ii) the fair market value of such property exceeds itsadjusted basis (in the hands of the distributingcorporation),

then gain shall be recognized to the distributing corporation as ifsuch property were sold to the distributee at its fair marketvalue.

(B) Qualified property

For purposes of this subsection, the term "qualified property"means--

(i) any stock in (or right to acquire stock in) the distributingcorporation or obligation of the distributing corporation, or

(ii) any stock in (or right to acquire stock in) anothercorporation which is a party to the reorganization orobligation of another corporation which is such a party if

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such stock (or right) or obligation is received by thedistributing corporation in the exchange.

Sec. 362Basis to corporations

(a) Property acquired by issuance of stock or as paid-in surplus

If property was acquired on or after June 22, 1954, by a corporation--

(1) in connection with a transaction to which section 351 (relating totransfer of property to corporation controlled by transferor) applies, or

(2) as paid-in surplus or as a contribution to capital,

then the basis shall be the same as it would be in the hands of thetransferor, increased in the amount of gain recognized to the transferor onsuch transfer.

(b) Transfers to corporations

If property was acquired by a corporation in connection with areorganization to which this part applies, then the basis shall be the same as

it would be in the hands of the transferor, increased in the amount of gainrecognized to the transferor on such transfer. This subsection shall not applyif the property acquired consists of stock or securities in a corporation aparty to the reorganization, unless acquired by the exchange of stock orsecurities of the transferee (or of a corporation which is in control of thetransferee) as the consideration in whole or in part for the transfer.

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Sec. 368Definitions relating to corporate reorganizations

(a) Reorganization

(1) In general

For purposes of parts I and II and this part, the term"reorganization" means--

(A) a statutory merger or consolidation;

(B) the acquisition by one corporation, in exchange solely for allor a part of its voting stock (or in exchange solely for all or a partof the voting stock of a corporation which is in control of the

acquiring corporation), of stock of another corporation if,immediately after the acquisition, the acquiring corporation hascontrol of such other corporation (whether or not such acquiringcorporation had control immediately before the acquisition);

(C) the acquisition by one corporation, in exchange solely for allor a part of its voting stock (or in exchange solely for all or a partof the voting stock of a corporation which is in control of theacquiring corporation), of substantially all of the properties ofanother corporation, but in determining whether the exchange issolely for stock the assumption by the acquiring corporation of a

liability of the other shall be disregarded;

(D) a transfer by a corporation of all or a part of its assets toanother corporation if immediately after the transfer thetransferor, or one or more of its shareholders (including personswho were shareholders immediately before the transfer), or anycombination thereof, is in control of the corporation to which theassets are transferred; but only if, in pursuance of the plan, stockor securities of the corporation to which the assets aretransferred are distributed in a transaction which qualifies undersection 354, 355, or 356;

(E) a recapitalization;

(F) a mere change in identity, form, or place of organization ofone corporation, however effected; or

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(G) a transfer by a corporation of all or part of its assets toanother corporation in a title 11 or similar case; but only if, inpursuance of the plan, stock or securities of the corporation towhich the assets are transferred are distributed in a transactionwhich qualifies under section 354, 355, or 356.

(2) Special rules relating to paragraph (1)

(A) Reorganizations described in both paragraph (1)(C) andparagraph (1)(D)

If a transaction is described in both paragraph (1)(C) andparagraph (1)(D), then, for purposes of this subchapter (otherthan for purposes of subparagraph (C)), such transaction shall betreated as described only in paragraph (1)(D).

(B) Additional consideration in certain paragraph (1)(C) cases

If--

(i) one corporation acquires substantially all of theproperties of another corporation,

(ii) the acquisition would qualify under paragraph (1)(C) butfor the fact that the acquiring corporation exchanges

money or other property in addition to voting stock, and

(iii) the acquiring corporation acquires, solely for votingstock described in paragraph (1)(C), property of the othercorporation having a fair market value which is at least 80percent of the fair market value of all of the property of theother corporation,

then such acquisition shall (subject to subparagraph (A) of thisparagraph) be treated as qualifying under paragraph (1)(C).

Solely for the purpose of determining whether clause (iii) of thepreceding sentence applies, the amount of any liability assumedby the acquiring corporation shall be treated as money paid forthe property.

(C) Transfers of assets or stock to subsidiaries in certainparagraph (1)(A), (1)(B), (1)(C), and (1)(G) cases

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A transaction otherwise qualifying under paragraph (1)(A), (1)(B), or (1)(C) shall not be disqualified by reason of the fact thatpart or all of the assets or stock which were acquired in thetransaction are transferred to a corporation controlled by thecorporation acquiring such assets or stock. A similar rule shall

apply to a transaction otherwise qualifying under paragraph (1)(G) where the requirements of subparagraphs (A) and (B) ofsection 354(b)(1) are met with respect to the acquisition of theassets.

(D) Use of stock of controlling corporation in paragraph (1)(A)and (1)(G) cases

The acquisition by one corporation, in exchange for stock of acorporation (referred to in this subparagraph as "controllingcorporation") which is in control of the acquiring corporation, of

substantially all of the properties of another corporation shall notdisqualify a transaction under paragraph (1)(A) or (1)(G) if--

(i) no stock of the acquiring corporation is used in thetransaction, and

(ii) in the case of a transaction under paragraph (1)(A),such transaction would have qualified under paragraph (1)(A) had the merger been into the controlling corporation.

(E) Statutory merger using voting stock of corporation controllingmerged corporation

A transaction otherwise qualifying under paragraph (1)(A)shall not be disqualified by reason of the fact that stock of acorporation (referred to in this subparagraph as the "controllingcorporation") which before the merger was in control of themerged corporation is used in the transaction, if--

(i) after the transaction, the corporation surviving themerger holds substantially all of its properties and of theproperties of the merged corporation (other than stock ofthe controlling corporation distributed in the transaction);and

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(ii) in the transaction, former shareholders of the survivingcorporation exchanged, for an amount of voting stock ofthe controlling corporation, an amount of stock in thesurviving corporation which constitutes control of suchcorporation.

(b) Party to a reorganization

For purposes of this part, the term "a party to a reorganization" includes--

(1) a corporation resulting from a reorganization, and

(2) both corporations, in the case of a reorganization resulting from the

acquisition by one corporation of stock or properties of another.

In the case of a reorganization qualifying under paragraph (1)(B) or (1)(C) ofsubsection (a), if the stock exchanged for the stock or properties is stock of acorporation which is in control of the acquiring corporation, the term "a partyto a reorganization" includes the corporation so controlling the acquiringcorporation. In the case of a reorganization qualifying under paragraph (1)(A), (1)(B), (1)(C), or (1)(G) of subsection (a) by reason of paragraph (2)(C) ofsubsection (a), the term "a party to a reorganization" includes thecorporation controlling the corporation to which the acquired assets or stock

are transferred. In the case of a reorganization qualifying under paragraph(1)(A) or (1)(G) of subsection (a) by reason of paragraph (2)(D) of thatsubsection, the term "a party to a reorganization" includes the controllingcorporation referred to in such paragraph (2)(D). In the case of areorganization qualifying under subsection (a)(1)(A) by reason of subsection(a)(2)(E), the term "party to a reorganization" includes the controllingcorporation referred to in subsection (a)(2)(E).

(c) Control defined

For purposes of part I (other than section 304), part II, this part, and part

V, the term "control" means the ownership of stock possessing at least 80percent of the total combined voting power of all classes of stock entitled tovote.

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Sec. 1032Exchange of stock for property

(a) Nonrecognition of gain or loss

No gain or loss shall be recognized to a corporation on the receipt ofmoney or other property in exchange for stock (including treasury stock) ofsuch corporation. No gain or loss shall be recognized by a corporation withrespect to any lapse or acquisition of an option, or with respect to asecurities futures contract (as defined in section 1234B), to buy or sell itsstock (including treasury stock).

(b) Basis

For basis of property acquired by a corporation in certain exchanges forits stock, see section 362.

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Sec. 1.355-2 Limitations.

(a) Property distributed.

Section 355 applies to a distribution only if the property distributedconsists solely of stock, or stock and securities, of a controlledcorporation. If additional property (including an excess principalamount of securities received over securities surrendered) is received,see section 356.

(b) Independent business purpose

(1) Independent business purpose requirement.

Section 355 applies to a transaction only if it is carried out forone or more corporate business purposes. A transaction iscarried out for a corporate business purpose if it is motivated, inwhole or substantial part, by one or more corporate businesspurposes. The potential for the avoidance of Federal taxes by thedistributing or controlled corporations (or a corporationcontrolled by either) is relevant in determining the extent towhich an existing corporate business purpose motivated thedistribution. The principal reason for this business purpose

requirement is to provide nonrecognition treatment only todistributions that are incident to readjustments of corporatestructures required by business exigencies and that effect onlyreadjustments of continuing interests in property under modifiedcorporate forms. This business purpose requirement isindependent of the other requirements under section 355.

(2) Corporate business purpose.

A corporate business purpose is a real and substantial nonFederal tax purpose germane to the business of the distributing

corporation, the controlled corporation, or the affiliated group (asdefined in section 1.355-3(b)(4)(iv)) to which the distributingcorporation belongs. A purpose of reducing non Federal taxes isnot a corporate business purpose if (i) the transaction will effecta reduction in both Federal and non Federal taxes because ofsimilarities between Federal tax law and the tax law of the otherjurisdiction and (ii) the reduction of Federal taxes is greater than

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or substantially coextensive with the reduction of non Federaltaxes. See examples (7) and (8) of paragraph (b)(5) of thissection. A shareholder purpose (for example, the personalplanning purposes of a shareholder) is not a corporate businesspurpose. Depending upon the facts of a particular case, however,

a shareholder purpose for a transaction may be so nearlycoextensive with a corporate business purpose as to precludeany distinction between them. In such a case, the transaction iscarried out for one or more corporate business purposes. Seeexample (2) of paragraph (b)(5) of this section.

(3) Business purpose for distribution.

The distribution must be carried out for one or more corporatebusiness purposes. See example (3) of paragraph (b)(5) of thissection. If a corporate business purpose can be achieved through

a nontaxable transaction that does not involve the distribution ofstock of a controlled corporation and which is neither impracticalnor unduly expensive, then, for purposes of paragraph (b)(1) ofthis section, the separation is not carried out for that corporatebusiness purpose. See examples (3) and (4) of paragraph (b)(5)of this section. For rules with respect to the requirement of abusiness purpose for a transfer of assets to a controlledcorporation in connection with a reorganization described insection 368(a)(1)(D), See section 1.368-1(b).

(4) Business purpose as evidence of nondevice.

The corporate business purpose or purposes for a transactionare evidence that the transaction was not used principally as adevice for the distribution of earnings and profits within themeaning of section 355(a)(1)(B). See paragraph (d)(3)(ii) of thissection.

(5) Examples.

The provisions of this paragraph (b) may be illustrated by thefollowing examples:

Example (1). Corporation X is engaged in the production,transportation, and refining of petroleum products. In 1985, Xacquires all of the properties of corporation Z, which is alsoengaged in the production, transportation, and refining ofpetroleum products. In 1991, as a result of antitrust litigation, Xis ordered to divest itself of all of the properties acquired from Z.

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X transfers those properties to new corporation Y and distributesthe stock of Y pro rata to X's shareholders. In view of thedivestiture order, the distribution is carried out for a corporatebusiness purpose. See paragraph (b)(1) of this section.

Example (2). Corporation X is engaged in two businesses: Themanufacture and sale of furniture and the sale of jewelry. Thebusinesses are of equal value. The outstanding stock of X isowned equally by unrelated individuals A and B. A is moreinterested in the furniture business, while B is more interested inthe jewelry business. A and B decide to split up the businessesand go their separate ways. A and B anticipate that theoperations of each business will be enhanced by the separationbecause each shareholder will be able to devote his undividedattention to the business in which he is more interested andmore proficient. Accordingly, X transfers the jewelry business to

new corporation Y and distributes the stock of Y to B in exchangefor all of B's stock in X. The distribution is carried out for acorporate business purpose, notwithstanding that it is alsocarried out in part for shareholder purposes. See paragraph (b)(2) of this section.

Example (3). Corporation X is engaged in the manufactureand sale of toys and the manufacture and sale of candy. Theshareholders of X wish to protect the candy business from therisks and vicissitudes of the toy business. Accordingly, Xtransfers the toy business to new corporation Y and distributes

the stock of Y to X's shareholders. Under applicable law, thepurpose of protecting the candy business from the risks andvicissitudes of the toy business is achieved as soon as Xtransfers the toy business to Y. Therefore, the distribution is notcarried out for a corporate business purpose. See paragraph (b)(3) of this section.

Example (4). Corporation X is engaged in a regulatedbusiness in State T. X owns all of the stock of corporation Y, aprofitable corporation that is not engaged in a regulatedbusiness. Commission C sets the rates that X may charge its

customers, based on its total income. C has recently adoptedrules according to which the total income of a corporationincludes the income of a business if, and only if, the business isoperated, directly or indirectly, by the corporation. Total income,for this purpose, includes the income of a wholly ownedsubsidiary corporation but does not include the income of aparent or "brother/sister" corporation. Under C's new rule, X's

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total income includes the income of Y, with the result that X hassuffered a reduction of the rates that it may charge itscustomers. It would not be impractical or unduly expensive tocreate in a nontaxable transaction (such as a transactionqualifying under section 351) a holding company to hold the

stock of X and Y. X distributes the stock of Y to X's shareholders.The distribution is not carried out for the purpose of increasingthe rates that X may charge its customers because that purposecould be achieved through a nontaxable transaction, the creationof a holding company, that does not involve the distribution ofstock of a controlled corporation and which is neither impracticalnor unduly expensive. See paragraph (b)(3) of this section.

Example (5). The facts are the same as in example (4), exceptthat C has recently adopted rules according to which the totalincome of a corporation includes not only the income included in

example (3), but also the income of any member of the affiliatedgroup to which the corporation belongs. In order to avoid areduction in the rates that it may charge its customers, Xdistributes the stock of Y to X's shareholders. The distribution iscarried out for a corporate business purpose. See paragraph (b)(3) of this section.

Example (6). (i) Corporation X owns all of the one class ofstock of corporation Y. X distributes the stock of Y pro rata to itsfive shareholders, all of whom are individuals, for the solepurpose of enabling X and/or Y to elect to become an S

corporation. The distribution does not meet the corporatebusiness purpose requirement. See paragraph (b) (1) and (2) ofthis section.

(ii) The facts are the same as in Example 6(i), except that thebusiness of Y is operated as a division of X. X transfers thisdivision to new corporation Y and distributes the stock of Y prorata to its shareholders, all of whom are individuals, for the solepurpose of enabling X and/or Y to elect to become an Scorporation. The distribution does not meet the corporatebusiness purpose requirement. See paragraph (b) (1) and (2) of

this section.

Example (7). The facts are the same as in example (6)(i),except that the distribution is made to enable X to elect tobecome an S corporation both for Federal tax purposes and forpurposes of the income tax imposed by State M. State M has taxlaw provisions similar to subchapter S of the Internal Revenue

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Code of 1986. An election to be an S corporation for Federal taxpurposes will effect a substantial reduction in Federal taxes thatis greater than the reduction of State M taxes pursuant to anelection to be an S corporation for State M purposes. Thepurpose of reducing State M taxes is not a corporate business

purpose. The distribution does not meet the corporate businesspurpose requirements. See paragraph (b) (1) and (2) of thissection.

Example (8). The facts are the same as Example (7), exceptthat the distribution also is made to enable A, a key employee ofY, to acquire stock of Y without investing in X. A is considered tobe critical to the success of Y and he has indicated that he willseriously consider leaving the company if he is not given theopportunity to purchase a significant amount of stock of Y. As amatter of state law, Y could not issue stock to the employee

while it was a subsidiary of X. As in Example (7), the purpose ofreducing State M taxes is not a corporate business purpose. Inorder to determine whether the issuance of stock to the keyemployee, in fact, motivated the distribution of the Y stock, thepotential avoidance of Federal taxes is a relevant factor to takeinto account. If the facts and circumstances establish that thedistribution was substantially motivated by the need to issuestock to the employee, the distribution will meet the corporatebusiness purpose requirement.

(c) Continuity of interest requirement

(1) Requirement.

Section 355 applies to a separation that effects only areadjustment of continuing interests in the property of thedistributing and controlled corporations. In this regard section355 requires that one or more persons who, directly or indirectly,were the owners of the enterprise prior to the distribution orexchange own, in the aggregate, an amount of stock establishinga continuity of interest in each of the modified corporate forms in

which the enterprise is conducted after the separation. Thiscontinuity of interest requirement is independent of the otherrequirements under section 355.

(2) Examples.

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Example (1). For more than five years, corporation X has beenengaged directly in one business, and indirectly in a differentbusiness through its wholly owned subsidiary, S. The businessesare equal in value. At all times, the outstanding stock of X hasbeen owned equally by unrelated individuals A and B. For valid

business reasons, A and B cause X to distribute all of the stock ofS to B in exchange for all of B's stock in X. After the transaction,A owns all the stock of X and B owns all the stock of S. Thecontinuity of interest requirement is met because one or morepersons who were the owners of X prior to the distribution (A andB) own, in the aggregate, an amount of stock establishing acontinuity of interest in each of X and S after the distribution.

Example (2). Assume the same facts as in Example (1),except that pursuant to a plan to acquire a stock interest in Xwithout acquiring, directly or indirectly, an interest in S, C

purchased one-half of the X stock owned by A and immediatelythereafter X distributed all of the S stock to B in exchange for allof B's stock in X. After the transactions, A owns 50 percent of Xand B owns 100 percent of S. The distribution by X of all of thestock of S to B in exchange for all of B's stock in X will satisfy thecontinuity of interest requirement for section 355 because one ormore persons who were the owners of X prior to the distribution(A and B) own, in the aggregate, an amount of stock establishinga continuity of interest in each of X and S after the distribution.

Example (3). Assume the same facts as in Examples (1) and

(2), except that C purchased all of the X stock owned by A. Afterthe transactions, neither A nor B own any of the stock of X, and Bowns all the stock of S. The continuity of interest requirement isnot met because the owners of X prior to the distribution (A andB) do not, in the aggregate, own an amount of stock establishinga continuity of interest in each of X and S after the distribution,i.e., although A and B collectively have retained 50 percent oftheir equity interest in the former combined enterprise, theyhave failed to continue to own the minimum stock interest in thedistributing corporation, X, that would be required in order tomeet the continuity of interest requirement.

Example (4). Assume the same facts as in Examples (1) and(2), except that C purchased 80 percent of the X stock owned byA. After the transactions, A owns 20 percent of the stock of X, Bowns no X stock, and B owns 100 percent of the S stock. Thecontinuity of interest requirement is not met because the ownersof X prior to the distribution (A and B) do not, in the aggregate,

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have a continuity of interest in each of X and S after thedistribution, i.e., although A and B collectively have retained 60percent of their equity interest in the former combinedenterprise, the 20 percent interest of A in X is less than theminimum equity interest in the distributing corporation, X, that

would be required in order to meet the continuity of interestrequirement.

(d) Device for distribution of earnings and profits

(1) In general.

Section 355 does not apply to a transaction used principallyas a device for the distribution of the earnings and profits of thedistributing corporation, the controlled corporation, or both (a

"device"). Section 355 recognizes that a tax-free distribution ofthe stock of a controlled corporation presents a potential for taxavoidance by facilitating the avoidance of the dividend provisionsof the Code through the subsequent sale or exchange of stock ofone corporation and the retention of the stock of anothercorporation. A device can include a transaction that effects arecovery of basis. In this paragraph (d), "exchange" includestransactions, such as redemptions, treated as exchanges underthe Code. Generally, the determination of whether a transactionwas used principally as a device will be made from all of the factsand circumstances, including, but not limited to, the presence of

the device factors specified in paragraph (d)(2) of this section("evidence of device"), and the presence of the nondevicefactors specified in paragraph (d)(3) of this section ("evidence ofnondevice"). However, if a transaction is specified in paragraph(d)(5) of this section, then it is ordinarily considered not to havebeen used principally as a device.

(2) Device factors

(i) In general.

The presence of any of the device factors specified inthis subparagraph (2) is evidence of device. The strengthof this evidence depends on the facts and circumstances.

(ii) Pro rata distribution.

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A distribution that is pro rata or substantially pro rataamong the shareholders of the distributing corporationpresents the greatest potential for the avoidance of thedividend provisions of the Code and, in contrast to othertypes of distributions, is more likely to be used principally

as a device. Accordingly, the fact that a distribution is prorata or substantially pro rata is evidence of device.

(iii) Subsequent sale or exchange of stock

(A) In general.

A sale or exchange of stock of the distributing orthe controlled corporation after the distribution (a"subsequent sale or exchange") is evidence of

device. Generally, the greater the percentage of thestock sold or exchanged after the distribution, thestronger the evidence of device. In addition, theshorter the period of time between the distributionand the sale or exchange, the stronger the evidenceof device.

(B) Sale or exchange negotiated or agreed uponbefore the distribution.

A subsequent sale or exchange pursuant to an

arrangement negotiated or agreed upon before thedistribution is substantial evidence of device.

(C) Sale or exchange not negotiated or agreed uponbefore the distribution.

A subsequent sale or exchange not pursuant to anarrangement negotiated or agreed upon before thedistribution is evidence of device.

(D) Negotiated or agreed upon before the

distribution.

For purposes of this subparagraph (2), a sale orexchange is always pursuant to an arrangementnegotiated or agreed upon before the distribution ifenforceable rights to buy or sell existed before thedistribution. If a sale or exchange was discussed by

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the buyer and the seller before the distribution andwas reasonably to be anticipated by both parties,then the sale or exchange will ordinarily beconsidered to be pursuant to an arrangementnegotiated or agreed upon before the distribution.

(E) Exchange in pursuance of a plan ofreorganization.

For purposes of this subparagraph (2), if stock isexchanged for stock in pursuance of a plan ofreorganization, and either no gain or loss or only aninsubstantial amount of gain is recognized on theexchange, then the exchange is not treated as asubsequent sale or exchange, but the stock receivedin the exchange is treated as the stock surrendered

in the exchange. For this purpose, gain treated as adividend pursuant to sections 356(a)(2) and 316 shallbe disregarded.

(iv) Nature and use of assets

(A) In general.

The determination of whether a transaction wasused principally as a device will take into account the

nature, kind, amount, and use of the assets of thedistributing and the controlled corporations (andcorporations controlled by them) immediately afterthe transaction.

(B) Assets not used in a trade or business meetingthe requirement of section 355(b).

The existence of assets that are not used in atrade or business that satisfies the requirements ofsection 355(b) is evidence of device. For this

purpose, assets that are not used in a trade orbusiness that satisfies the requirements of section355(b) include, but are not limited to, cash and otherliquid assets that are not related to the reasonableneeds of a business satisfying such section. Thestrength of the evidence of device depends on all thefacts and circumstances, including, but not limited

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to, the ratio for each corporation of the value ofassets not used in a trade or business that satisfiesthe requirements of section 355(b) to the value of itsbusiness that satisfies such requirements. Adifference in the ratio described in the preceding

sentence for the distributing and controlledcorporation is ordinarily not evidence of device if thedistribution is not pro rata among the shareholders ofthe distributing corporation and such difference isattributable to a need to equalize the value of thestock distributed and the value of the stock orsecurities exchanged by the distributees.

(C) Related function.

There is evidence of device if a business of either

the distributing or controlled corporation (or acorporation controlled by it) is (1) a "secondarybusiness" that continues as a secondary business fora significant period after the separation, and (2) canbe sold without adversely affecting the business ofthe other corporation (or a corporation controlled byit). A secondary business is a business of either thedistributing or controlled corporation, if its principalfunction is to serve the business of the othercorporation (or a corporation controlled by it). Asecondary business can include a business

transferred to a newly-created subsidiary or abusiness which serves a business transferred to anewly-created subsidiary. The activities of thesecondary business may consist of providingproperty or performing services. Thus, in example(11) of section 1.355-3(c), evidence of device wouldbe presented if the principal function of the coalmine (satisfying the requirements of the steelbusiness) continued after the separation and the coalmine could be sold without adversely affecting thesteel business. Similarly, in example (10) of section

1.355-3(c), evidence of device would be presented ifthe principal function of the sales operation after theseparation is to sell the output from themanufacturing operation and the sales operationcould be sold without adversely affecting themanufacturing operation.

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(3) Nondevice factors

(i) In general.

The presence of any of the nondevice factors specified

in this subparagraph (3) is evidence of nondevice. Thestrength of this evidence depends on all of the facts andcircumstances.

(ii) Corporate business purpose.

The corporate business purpose for the transaction isevidence of nondevice. The stronger the evidence ofdevice (such as the presence of the device factorsspecified in paragraph (d)(2) of this section), the strongerthe corporate business purpose required to prevent the

determination that the transaction was used principally asa device. Evidence of device presented by the t