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Tax law can be described as a fairly earth-bound discipline; it exists within purportedly fixed parameters, and we generally approach each question on the basis that there exists an objectively correct answer to it. Indeed, I daresay that this is to a large degree what we find appealing about it, we who enjoy solving mathematical problems that have a solution but have never managed to make it through a Stephen Hawking book.

People who have delved into the outer boundaries of science have occasionally noted that microphysics bears a certain resemblance to astrophysics. Looking into the lens of an extremely high powered electron microscope is not so different from looking into the lens of an extremely high powered telescope. And this is how I sometimes feel about “F” reorganizations.

How's that, you say? Depending on how you look at it, the definition of an F reorganization is so restrictive as to rule out nearly anything interesting that might occur in a business transaction, or alternatively, so expansive as to make the F reorganization virtually ubiquitous. The statutory definition in §368(a)(1)(F) is “a mere change in identity, form, or place of organization of one corporation, however effected.” Until modified in the current regulations, a super-strict “identity of interest” requirement was imposed, under which there could be no more than a de minimis change in the underlying share holdings. While Rev. Rul. 66-284, 1966-2 C.B. 115, allowed a 1% change in shareholders, by only doing so on the basis of it being a de minimis change, it affirmed a strict rule generally allowing no change.

For years, the IRS's position was that many transactions would fail as F reorganizations because they were not “mere” enough. This stood in contrast, though, to the expansive approach for which the IRS had sometimes argued when asserting that a liquidation-reincorporation transaction should be characterized as an F reorganization with dividend treatment to the shareholders.¹

In recent years, there has been a growing recognition that while one could consider the requirement that an F reorganization involve no more than a “mere change in form, etc.” to be a highly restrictive concept, it could alternatively be considered quite liberating. Rev. Rul. 96-29, 1996-1 C.B. 50, explicitly set forth the proposition that because the F reorganization is by definition so innocuous, it can occur comfortably in conjunction with nearly any other transaction and not affect, or be affected by, the other transaction. The F reorganization thus becomes the Forrest Gump, or (for you older readers), the Zelig, of reorganizations. You can color it into any scene and it will fit right in.

More recently, the IRS and Treasury embarked on a more ambitious project. In 2004, they issued proposed regulations purporting to redefine the boundaries for F reorganizations in the liberated world of Rev. Rul. 96-29. One important change was to eliminate the continuity of interest and continuity of business enterprise requirements for F reorganizations, in full recognition of the fact that the F reorganization no more needed these restrictions than the other “single entity” E reorganization. This aspect of the proposed regulations has since been codified in a final regulation.

On a more ambitious path, the proposed regulations asked what exactly it could mean to say, as Rev. Rul. 96-29 essentially does, that the step transaction doctrine is “turned off,” in relation to testing an F reorganization occurring in conjunction with other transactions. The main rule set forth in Prop. Regs. §1.368-2(m)(1)(i) limits F reorganizations involving a transfer from an Oldco to a Newco to those where (A) all the stock of Newco is issued in respect of stock of Oldco; (B) there is no change in ownership between Oldco and Newco, except for a redemption of Oldco shareholders; (C) Oldco completely liquidates; and (D) Newco holds no property and has no tax attributes before the transfer.

The meat of the regulation with respect to the step transaction doctrine is contained in Prop. Regs. §1.368-2(m)(3). We have a recitation of the principle of Rev. Rul. 96-29 that the F reorganization stands alone, unmolested, when it occurs as part of a larger transaction. This principle, along with the rule eliminating continuity of interest, is exemplified in Example 6, where a prearranged sale of all the Newco stock does not run afoul of the above requirement that there be an identity of shareholders before and after the F reorganization. The proposed regulation also makes very clear what had only been hinted at in current Regs. §1.301-1(l) that distributions occurring in conjunction with F reorganizations are not considered boot under §356, but are treated as ordinary distributions under §301 or §302.

Where things get difficult is when people start to ask why the IRS is drawing lines where it does. As we said above, a shareholder can put his corporation through an F reorganization as part of a plan to sell all the stock to an unrelated party. So why can't the same result be achieved if the unrelated party forms Newco with cash and merges Oldco into it? Example 1 in the proposed regulations says that this does not qualify as an F reorganization. And by the way, if it is not an F, then under Rev. Rul. 69-6, 1969-1 C.B. 104, it also will not qualify as an A reorganization and will be treated as a taxable asset sale. Well, that is the fairly clear result under the proposed regulation, but when a commentator cries “Foul! You're glorifying form over substance!” the IRS may find itself a bit taken aback.

Taken to its logical conclusion, such an attack could lead to a set of regulations not unlike the temporary D reorganization regulations, which set forth the rule that a sale of substantially all of a corporation's assets to a related corporation coupled with a liquidation must be treated as a D reorganization. The analogue here would be a rule stating that when a series of integrated transactions results in one corporation disappearing and its assets ending up in another corporation that was formed as part of the same plan, the transaction is treated as an F reorganization. All new shareholders is not a problem. But going further, with the principle that the F reorganization can coexist with other disqualifying events, why stop there? What if Newco promptly merges into another preexisting corporation owned by the new shareholders?

I cannot be sure that this is why the proposed regulations remain in proposed form for the time being. But I believe that this is the core dilemma that confronts the IRS as it tries to set forth clear but flexible standards for F reorganizations. The challenge is to articulate, with clarity and a clear conscience, rules that the practical tax advisor can follow to distinguish what is and what is not an F reorganization, and leave to philosophers to debate whether F reorganizations can be found everywhere.

For more information, in the Tax Management Portfolios, see Kliegman, 774 T.M., Single Entity Reorganizations: Recapitalizations, and in Tax Practice Series, see ¶4910, Corporate Reorganizations.