## Facts

- The Department of the Treasury and the Internal Revenue Service issued final regulations addressing the continuity of interest (COI) and continuity of business enterprise (COBE) requirements for corporate reorganizations under I.R.C. § 368.
- The final rule principally amended Treas. Reg. §§ 1.368-1(d) (COBE) and 1.368-1(e) (COI), and made related conforming changes, including to §§ 1.338-2, 1.368-1(a)–(b), and 1.368-2(k).
- The regulations followed notice-and-comment rulemaking: proposed regulations were published in late 1996 and early 1997, written comments were received, and a public hearing was held on May 7, 1997.
- The rule was adopted as final, with revisions responding to comments, and became effective on January 28, 1998.
- The regulations generally apply to transactions occurring after January 28, 1998, with an exception for transactions carried out under written agreements that were binding (subject to customary conditions) on that date and remained binding thereafter.
- The rule was intended to provide administrable standards for when a transaction qualifies as a reorganization rather than a sale, particularly for deals involving mixed consideration, related-party structures, and post-transaction transfers.

## Issues

1. What regulatory standards determine whether a transaction satisfies the COI requirement for nonrecognition treatment under I.R.C. § 368, including the effect of related-party acquisitions and shareholder cash-outs?
2. What regulatory standards determine whether a transaction satisfies the COBE requirement, including what constitutes continuation of the target’s historic business or use of its historic business assets?
3. When do post-reorganization transfers of acquired stock or assets (including to controlled entities or certain partnerships) affect COI, COBE, or “remote” continuity concepts?

## Decision

- Treasury adopted final COI regulations in Treas. Reg. § 1.368-1(e) to clarify how continuity is measured and when arrangements operate as cash-outs inconsistent with COI.
- Treasury adopted final COBE regulations in Treas. Reg. § 1.368-1(d) stating that COBE is satisfied if the acquiring corporation (or a qualified group member) continues the target’s historic business or uses a significant portion of the target’s historic business assets in a business.
- Treasury issued rules addressing post-reorganization transfers and “remote” continuity concepts, including provisions under Treas. Reg. § 1.368-2(k), specifying circumstances in which transfers to controlled corporations and certain partnerships do not disqualify an otherwise qualifying reorganization.
- Treasury revised the definition of “related person” in response to comments, narrowing it and using a two-part approach to target (i) affiliated-group relationships and (ii) relationships producing effects comparable to redemptions addressed by I.R.C. § 304(a)(2).
- The final rule rejected reliance on older, difficult-to-administer remote continuity approaches associated with prior Supreme Court doctrine, favoring clearer, regulation-based standards.

## Legal Principles

- COI functions to prevent transactions resembling sales from receiving reorganization nonrecognition treatment; continuity generally requires that target shareholders retain a substantial proprietary interest through equity in the acquiring corporation (or specified related corporations), rather than being cashed out.
- For COI purposes, certain acquisitions of target stock for cash by corporations related to the equity-issuing corporation are treated as cash-outs that do not preserve continuity, with relatedness tested to prevent relationship engineering in connection with the reorganization.
- COBE is satisfied when the acquiring corporation (or a qualified affiliate) continues the target’s historic business or uses a significant portion of the target’s historic business assets in a business after the transaction.
- Post-reorganization transfers of acquired assets or stock to controlled entities, and under specified conditions to partnerships, may be disregarded for continuity purposes so that organizational structuring does not, by itself, defeat COI or COBE.
- The regulations apply prospectively to post-effective-date transactions, with limited grandfathering for qualifying transactions under binding written agreements in place on the effective date.

## Conclusion

T.D. 8760 established comprehensive final regulations for COI and COBE under § 368, defining when shareholder equity continuity and post-transaction business continuation are sufficient for reorganization treatment, while treating certain related-party cash-out structures as inconsistent with continuity and permitting specified post-transaction transfers without disqualification.


Continuity of Interest & Continuity of Business Enterprise, T.D. 8760, 1998-1 C.B. 803 (1998)