Prop. Treas. Reg. § 1.355-3 Active conduct of a trade or business.

Par. 2. Section 1.355-0 is amended by revising the entries under § 1.355-3.

Par. 4. Section 1.355-3 is revised to read as follows:

(a) General requirements.

(b) Active conduct of a trade or business defined.

(1) In general.

(i) Directly engaged in a trade or business.

(ii) Treatment of a separate affiliated group.

(iii) Separate affiliated group defined.

(2) Active conduct of a trade or business immediately after the distribution.

(i) In general.

(ii) Trade or business.

(iii) Active conduct.

(iv) Limitations.

(v) Partner attributed the trade or business assets and activities of a partnership.

(A) In general.

(B) Significant interest.

(C) Meaningful interest.

(D) Other factors.

(3) Active conduct for the pre-distribution period.

(i) In general.

(ii) Change and expansion.

(iii) Certain transactions with partnerships that do not constitute acquisitions.

(4) Special rules for an acquisition of a trade or business.

(i) In general.

(A) Application of section 355(b)(2)(C).

(B) Application of section 355(b)(2)(D).

(C) Gain or loss recognized.

(ii) Certain transactions treated as transactions in which gain or loss is recognized.

(A) Certain tax-free acquisitions made in exchange for assets.

(B) Distributions from partnerships.

(iii) Certain transactions in which recognized gain or loss is disregarded.

(A) Transfers to controlled.

(B) Cash for fractional shares.

(C) Certain acquisitions of control of distributing.

(iv) Operating rules for acquisitions.

(A) Predecessors.

(B) Certain multi-step acquisitions of control of distributing or controlled.

(C) Certain multi-step acquisitions of a subsidiary SAG member.

(D) Certain multi-step asset acquisitions.

(E) Acquisitions involving the issuance of subsidiary stock.

(F) Acquisitions of controlled stock where controlled is or becomes a DSAG member.

(G) Treatment of stock received in certain tax-free exchanges.

(H) Situations where the separate existence of a subsidiary SAG member is respected.

(c) Definitions.

(1) Affiliate.

(2) Controlled.

(3) Distributing.

(4) Pre-distribution period.

(d) Conventions and examples.

(1) Conventions.

(2) Examples.

* * * * *

(a) General requirements. Under section 355(b)(1), a distribution of stock, or stock and securities, of controlled (as defined in paragraph (c)(2) of this section) qualifies under section 355 only if—

(1) Distributing (as defined in paragraph (c)(3) of this section) and controlled are each engaged in the active conduct of a trade or business immediately after the distribution (section 355(b)(1)(A)); or

(2) Immediately before the distribution, distributing had no assets other than stock or securities of the controlled corporations (without regard to paragraph (b)(1)(ii) of this section), and each of the controlled corporations is engaged in the active conduct of a trade or business immediately after the distribution (section 355(b)(1)(B)). A de minimis amount of assets held by distributing shall be disregarded for purposes of this paragraph (a)(2).

(b) Active conduct of a trade or business defined —(1) In general —(i) Directly engaged in a trade or business . Section 355(b)(2) provides rules for determining whether a corporation is treated as engaged in the active conduct of a trade or business under section 355(b)(1). Sections 355(b)(2)(A) and (b)(3)(A) provide that a corporation is treated as engaged in the active conduct of a trade or business if and only if such corporation is engaged in the active conduct of a trade or business. Accordingly, except as provided in paragraph (b)(1)(ii) of this section, a corporation is not treated as engaged in the active conduct of a trade or business under such Internal Revenue Code sections solely as a result of substantially all of its assets consisting of stock, or stock and securities, of one or more corporations controlled by it (immediately after the distribution) each of which is engaged in the active conduct of a trade or business.

(ii) Treatment of a separate affiliated group. Under section 355(b)(3)(B), solely for purposes of determining whether a corporation is engaged in the active conduct of a trade or business, all members of a corporation's separate affiliated group (SAG) (as defined in paragraph (b)(1)(iii) of this section) shall be treated as one corporation. This treatment applies for all purposes of determining whether a corporation is engaged in the active conduct of a trade or business. Accordingly, for this purpose, transfers of assets (or activities) that are owned (or performed) by the SAG immediately before and immediately after the transfer are disregarded and are not acquisitions under paragraph (b)(4) of this section. Further, a transaction that results in a corporation becoming a subsidiary SAG member (a SAG member that is not the common parent of such SAG) is treated as an acquisition of any assets (or activities) that are owned (or performed) by the acquired corporation at such time. Therefore, the acquisition of additional stock of a current subsidiary SAG member has no effect for purposes of applying paragraph (b)(4)(i)(A) of this section.

(iii) Separate affiliated group defined. A corporation's SAG is the affiliated group which would be determined under section 1504(a) if such corporation were the common parent and section 1504(b) did not apply. Thus, the separate affiliated group of distributing (DSAG) is the affiliated group that consists of distributing as the common parent and all corporations affiliated with distributing through stock ownership described in section 1504(a)(1)(B) (regardless of whether the corporations are includible corporations under section 1504(b)). The separate affiliated group of controlled (CSAG) is determined in a similar manner (with controlled as the common parent). Accordingly, prior to a distribution, the DSAG may include CSAG members if the applicable ownership requirements are met. Further, the determination of whether a corporation is a DSAG or CSAG member shall be made separately for each distribution, and without regard to whether such corporation is a SAG member with respect to any other distribution. Any reference to DSAG or CSAG is a reference to distributing or controlled, respectively, if such corporation is not the common parent of a SAG (that is, such corporation does not own stock in any corporation that is a subsidiary member of its SAG). Further, any reference to a SAG is a reference to distributing or controlled, as the context may require, if such corporation is not the common parent of a SAG.

(2) Active conduct of a trade or business immediately after the distribution —(i) In general . For purposes of section 355(b), a corporation shall be treated as engaged in the active conduct of a trade or business immediately after the distribution if the assets and activities of the corporation satisfy the requirements and limitations described in paragraphs (b)(2)(ii), (b)(2)(iii), and (b)(2)(iv) of this section. See paragraph (b)(2)(v) of this section for additional special rules that apply to determine whether a corporation is attributed the trade or business assets and activities of a partnership.

(ii) Trade or business. A corporation shall be treated as engaged in a trade or business immediately after the distribution if a specific group of activities is being carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation that forms a part of, or a step in, the process of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.

(iii) Active conduct. For purposes of section 355(b), the determination of whether a trade or business is actively conducted will be made from all of the facts and circumstances. Generally, the corporation is required itself to perform active and substantial management and operational functions. Activities performed by a corporation include activities performed by employees of an affiliate (as defined in paragraph (c)(1) of this section), and in certain cases by shareholders of a closely held corporation, if such activities are performed for the corporation. For example, activities performed by a corporation include activities performed for the corporation by its sole shareholder. However, the activities of employees of affiliates (or, in certain cases, shareholders) are only taken into account during the period such corporations are affiliates (or persons are shareholders) of the corporation. A corporation will not be treated as engaged in the active conduct of a trade or business unless it (or its SAG, or a partnership from which the trade or business assets and activities are attributed) is the principal owner of the goodwill and significant assets of the trade or business for Federal income tax purposes. Activities performed by a corporation generally do not include activities performed by persons outside the corporation, including independent contractors, unless those activities are performed by employees of an affiliate (or, in certain cases, by shareholders). However, a corporation may satisfy the requirements of this paragraph (b)(2)(iii) through the activities that it performs itself, even though some of its activities are performed by persons that are not its employees, or employees of an affiliate (or, in certain cases, shareholders). Separations of real property all or substantially all of which is occupied before the distribution by the DSAG or CSAG will be carefully scrutinized in applying the requirements of section 355(b) and this section.

(iv) Limitations. The active conduct of a trade or business does not include—

(A) The holding for investment purposes of stock, securities, land, or other property; or

(B) The ownership and operation (including leasing) of real or personal property used in a trade or business, unless the owner performs significant services with respect to the operation and management of the property.

(v) Partner attributed the trade or business assets and activities of a partnership —(A) In general. For purposes of section 355(b), a partner in a partnership will be attributed the trade or business assets and activities of that partnership during the period that such partner satisfies the requirements of paragraph (b)(2)(v)(B) or (b)(2)(v)(C) of this section. However, for purposes of this paragraph (b)(2)(v), the stock of a corporation owned by the partnership is not attributed to a partner. For purposes of determining the activities that are conducted by the partnership that may be attributed to the partner under this paragraph (b)(2)(v), the activities of independent contractors, and partners that are not affiliates (or, in certain cases, shareholders) of the partner, are not taken into account. For this purpose, the activities of partners that are affiliates (or, in certain cases, shareholders) of the partner are only taken into account during the period that such partners are affiliates (or, in certain cases, shareholders) of the partner.

(B) Significant interest. The trade or business assets and activities of a partnership will be attributed to a partner if the partner (or its SAG) directly (or indirectly through one or more other partnerships) owns a significant interest in the partnership.

(C) Meaningful interest. The trade or business assets and activities of a partnership will be attributed to a partner if the partner or affiliates (or, in certain cases, shareholders) of the partner performs active and substantial management functions for the partnership with respect to the trade or business assets and activities (for example, makes decisions regarding significant business issues of the partnership and regularly participates in the overall supervision, direction, and control of the employees performing the operational functions for the partnership), and the partner (or its SAG) directly (or indirectly through one or more other partnerships) owns a meaningful interest in the partnership. Whether such active and substantial management functions are performed with respect to the trade or business assets and activities of the partnership will be determined from all of the facts and circumstances. The number of partners providing management functions will not be determinative.

(D) Other factors. In deciding whether the requirements of paragraph (b)(2)(v)(B) or (b)(2)(v)(C) of this section are satisfied, the formal description of the partnership interest (for example, general or limited) will not be determinative and the extent to which the partner is responsible for liabilities of the partnership will not be relevant.

(3) Active conduct for the pre-distribution period —(i) In general. Under section 355(b)(2), a trade or business that is relied upon to meet the requirements of section 355(b) must have been actively conducted throughout the pre-distribution period (as defined in paragraph (c)(4) of this section) by the DSAG or CSAG, or actively conducted throughout the pre-distribution period and acquired during such period by the DSAG or CSAG in a transaction in which no gain or loss is recognized as provided in paragraph (b)(4) of this section. For purposes of section 355(b)(2)(B), activities that constitute a trade or business under paragraph (b)(2) of this section shall be treated as described in the preceding sentence if such activities were actively conducted throughout the pre-distribution period.

(ii) Change and expansion. The fact that a trade or business underwent change during the pre-distribution period (for example, by the addition of new or the dropping of old products, changes in production capacity, and the like) shall be disregarded, provided that the changes are not of such a character as to constitute the acquisition of a new or different business. In particular, if a SAG engaged in the active conduct of one trade or business during the pre-distribution period (the original business) purchased, created, or otherwise acquired (either directly, through an interest in a partnership, or as a result of a corporation becoming a subsidiary SAG member) another trade or business (the acquired business) in the same line of business, the acquisition of the acquired business is ordinarily treated as an expansion of the original business, all of which is treated as having been actively conducted by the acquiring SAG during the pre-distribution period, unless the acquired business effects a change of such a character as to constitute the acquisition of a new or different business. For purposes of this paragraph (b)(3)(ii), in determining whether an acquired business is in the same line of business as the original business, all facts and circumstances shall be considered, including the following—

(A) Whether the product of the acquired business is similar to that of the original business;

(B) Whether the business activities associated with the operation of the acquired business are the same as the business activities associated with the operation of the original business; and

(C) Whether the operation of the acquired business involves the use of the experience and know-how that the owner of the original business developed in the operation of the original business or, alternatively, whether the operation of the acquired business draws to a significant extent on the existing experience and know-how of the owner of the original business and the success of the acquired business will depend in large measure on the goodwill associated with the original business and the name of the original business.

(iii) Certain transactions with partnerships that do not constitute acquisitions. If a partner is attributed the trade or business assets and activities of a partnership under paragraph (b)(2)(v) of this section, the partner's acquisition of such trade or business assets and activities from the partnership is not, in and of itself, the acquisition of a new or different trade or business. In addition, if a partner transfers to a partnership trade or business assets and activities that the partner actively conducted immediately before the transfer and, immediately after the transfer, the partner is attributed the trade or business assets and activities of the partnership under paragraph (b)(2)(v) of this section, such transfer is not, in and of itself, the acquisition of a new or different trade or business by the transferor partner.

(4) Special rules for an acquisition of a trade or business —(i) In general —(A) Application of section 355(b)(2)(C) . Under sections 355(b)(2)(C) and (b)(3), a trade or business or an interest in a partnership engaged in a trade or business relied on to meet the requirements of section 355(b) must not have been acquired by either the DSAG or CSAG during the pre-distribution period unless it was acquired in a transaction in which no gain or loss was recognized. Further, a trade or business must not have been acquired by either the DSAG or CSAG during the pre-distribution period as a result of a corporation becoming a subsidiary SAG member unless such corporation became a subsidiary SAG member as a result of one or more transactions in which no gain or loss was recognized or by reasons of such transactions combined with acquisitions before the pre-distribution period. This paragraph (b)(4)(i)(A) also applies with respect to any acquisition during the pre-distribution period of a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business by a corporation that later becomes a subsidiary SAG member. See paragraphs (b)(4)(iv)(C) and (b)(4)(iv)(D) of this section regarding the application of this paragraph (b)(4)(i)(A) to certain multi-step acquisitions.

(B) Application of section 355(b)(2)(D). Under section 355(b)(2)(D), control of distributing must not have been acquired (at the time it was conducting the trade or business to be relied on) directly or indirectly by any distributee corporation, and control of controlled must not have been acquired (at the time it was conducting the trade or business to be relied on) directly or indirectly by the DSAG, during the pre-distribution period in one or more transactions in which gain or loss was recognized. This paragraph (b)(4)(i)(B) also applies with respect to any acquisition of stock of controlled during the pre-distribution period by a corporation that later becomes a DSAG member. For purposes of this paragraph (b)(4)(i)(B), and paragraphs (b)(4)(iii)(C) and (b)(4)(iv)(B) of this section, all distributee corporations that are affiliates shall be treated as one distributee corporation. This paragraph (b)(4)(i)(B) does not apply with respect to an acquisition of stock of any corporation other than distributing or controlled. See paragraph (b)(4)(iv)(B) of this section regarding the application of this paragraph (b)(4)(i)(B) to certain multi-step acquisitions of control. Further, see paragraph (b)(4)(iv)(F) of this section regarding certain acquisitions of stock in controlled to which paragraph (b)(4)(i)(A) of this section (and not this paragraph (b)(4)(i)(B)) applies.

(C) Gain or loss recognized. Any reference to gain or loss recognized includes gain or loss treated as recognized under paragraphs (b)(4)(ii) or (b)(4)(iv) of this section.

(ii) Certain transactions treated as transactions in which gain or loss is recognized. The common purpose of section 355(b)(2)(C) and (D) is to prevent the direct or indirect acquisition of the trade or business to be relied on by a corporation in exchange for assets in anticipation of a distribution to which section 355 would otherwise apply. Generally, if a DSAG member or controlled acquires the trade or business solely in exchange for distributing stock, distributing acquires control of controlled solely in exchange for distributing stock, or controlled acquires the trade or business from distributing solely in exchange for stock of controlled, in a transaction in which no gain or loss was recognized, the requirements of section 355(b)(2)(C) and (D) are satisfied. On the other hand, if the trade or business is acquired in exchange for assets of distributing (other than stock of a corporation in control of distributing used in a reorganization) the requirements of section 355(b)(2)(C) and (D) are generally not satisfied. For example, acquisitions by controlled (while controlled by distributing) from an unrelated party made in exchange for controlled stock have the effect of an indirect acquisition by distributing in exchange for distributing's assets. Such acquisitions violate the purpose of section 355(b)(2)(C) even if no gain or loss is recognized. Therefore, as provided in paragraphs (b)(4)(ii)(A) and (b)(4)(ii)(B) of this section, if the DSAG or CSAG acquires a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business in exchange for assets of the DSAG in a transaction in which no gain or loss is recognized, for purposes of paragraph (b)(4)(i) of this section such acquisition will be treated as one in which gain or loss is recognized.

(A) Certain tax-free acquisitions made in exchange for assets. An acquisition paid for in whole or in part, directly or indirectly, with assets of the DSAG will be treated as an acquisition in which gain or loss is recognized even if no gain or loss is actually recognized. Acquisitions described in this paragraph (b)(4)(ii)(A) include for example, a transaction in which the DSAG or CSAG acquires stock of a corporation engaged in the trade or business to be relied on by transferring assets not constituting the trade or business to be relied on to such corporation in exchange for stock of such corporation, the DSAG or CSAG acquires an interest in a partnership engaged in the trade or business to be relied on by contributing assets not constituting the trade or business to be relied on to the partnership, the DSAG or CSAG acquires stock of a corporation engaged in the trade or business in an exchange to which section 304(a)(1) applies, or distributing acquires a trade or business in exchange for its stock and assets in a transaction in which no loss is recognized by virtue of section 351(b). See also paragraph (b)(4)(iv)(E) of this section regarding the extent to which an acquisition involving the issuance of subsidiary stock constitutes an acquisition paid for with assets. However, the assumption by the DSAG or CSAG of liabilities of a transferor shall not, in and of itself, be treated as the payment of assets if such assumption is not treated as the payment of money or other property under any other applicable provision. In addition, an acquisition in which no gain or loss is recognized consisting of a pro rata distribution to which section 355 applies (to the extent the stock with respect to which the distribution is made was not acquired during the pre-distribution period in a transaction in which gain or loss was recognized), a distribution from a partnership that is explicitly excluded from paragraph (b)(4)(ii)(B) of this section, a reorganization described in section 368(a)(1)(E) or (F), and an exchange to which section 1036 applies, are not acquisitions described in this paragraph (b)(4)(ii)(A).

(B) Distributions from partnerships. An acquisition consisting of a distribution from a partnership is generally an acquisition paid for with assets of the DSAG, and will be treated as an acquisition in which gain or loss is recognized even if no gain or loss is actually recognized. However, an acquisition consisting of a pro rata distribution from a partnership of stock or an interest in lower-tier partnership is not an acquisition described in this paragraph (b)(4)(ii)(B) (and consequently not described in paragraph (b)(4)(ii)(A) of this section) to the extent the distributee partner did not acquire the interest in the distributing partnership during the pre-distribution period in a transaction in which gain or loss was recognized and to the extent the distributing partnership did not acquire the distributed stock or partnership interest within such period. This paragraph (b)(4)(ii)(B) (and consequently paragraph (b)(4)(ii)(A) of this section) does not apply to any partnership distribution to which paragraph (b)(3)(iii) of this section (regarding distributions from partnerships that are not, in and of themselves, the acquisition of a new or different trade or business) applies.

(iii) Certain transactions in which recognized gain or loss is disregarded. The common purpose of section 355(b)(2)(C) and (D) is to prevent the direct or indirect acquisition of the trade or business to be relied on by a corporation in exchange for assets in anticipation of a distribution to which section 355 would otherwise apply. An additional purpose of section 355(b)(2)(D) is to prevent a distributee corporation from acquiring control of distributing in anticipation of a distribution to which section 355 would otherwise apply, enabling the disposition of controlled stock without recognizing the appropriate amount of gain. The acquisitions described in paragraphs (b)(4)(iii)(A) through (b)(4)(iii)(C) of this section are not the types of acquisitions to which section 355(b)(2)(C) or (D) is intended to apply. Therefore, for purposes of paragraph (b)(4)(i) of this section, the recognition of gain or loss is disregarded if a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business is acquired in a transaction described in any of paragraphs (b)(4)(iii)(A) through (b)(4)(iii)(C) of this section.

(A) Transfers to controlled. An acquisition by the CSAG from the DSAG provided the DSAG controls controlled immediately after the acquisition.

(B) Cash for fractional shares. An acquisition that would satisfy the requirements of paragraph (b)(4)(i) of this section but for the payment of cash to shareholders for fractional shares in the transaction, provided that the cash paid represents a mere rounding off of the fractional shares in the exchange and is not separately bargained for consideration.

(C) Certain acquisitions of control of distributing. A direct or indirect acquisition by a distributee corporation of control of distributing, in one or more transactions, where the basis of the acquired distributing stock in the hands of the distributee corporation is determined in whole by reference to the transferor's basis. This paragraph (b)(4)(iii)(C) is only applicable with respect to a distribution by the acquired distributing, and does not apply for purposes of any subsequent distribution by any distributee corporation.

(iv) Operating rules for acquisitions —(A) Predecessors. References to a corporation shall include references to a predecessor of such corporation. For this purpose, a predecessor of a corporation is a corporation that transfers its assets to such corporation in a transaction to which section 381 applies.

(B) Certain multi-step acquisitions of control of distributing or controlled. A distributee corporation's acquisition of stock in distributing or a DSAG's acquisition of stock in controlled in one or more transactions in which gain or loss was recognized during the pre-distribution period will not prevent a distributee corporation's acquisition of distributing stock or a DSAG's acquisition of controlled stock constituting control of distributing or controlled in one or more separate transactions in which no gain or loss is recognized from satisfying the requirements of paragraph (b)(4)(i)(B) of this section, provided that, at the time control of distributing or controlled is first acquired, the acquiring distributee corporation owns an amount of distributing stock or the acquiring DSAG owns an amount of controlled stock, as the case may be, constituting control that was acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the pre-distribution period. The principles of this paragraph (b)(4)(iv)(B) will be applied with respect to an indirect acquisition of distributing or controlled stock.

(C) Certain multi-step acquisitions of a subsidiary SAG member. An acquisition of stock in a corporation (target) by a SAG in one or more transactions in which gain or loss was recognized during the pre-distribution period will not prevent a SAG's acquisition of target stock resulting in target becoming a subsidiary SAG member in one or more separate transactions in which no gain or loss is recognized from satisfying the requirements of paragraph (b)(4)(i)(A) of this section, provided that, at the time that target first becomes a subsidiary SAG member, the SAG owns an amount of target stock meeting the requirements of section 1504(a)(2) that was acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the pre-distribution period. The principles of this paragraph (b)(4)(iv)(C) will be applied with respect to an indirect acquisition of target stock by the SAG.

(D) Certain multi-step asset acquisitions. Notwithstanding paragraph (b)(4)(i)(A) of this section, if immediately before a SAG's direct acquisition of a trade or business (or an interest in a partnership engaged in a trade or business) held by a corporation (owner) in a transaction to which section 381 applies and in which no gain or loss is recognized, the SAG owns an amount of stock of the owner that it acquired in one or more transactions during the pre-distribution period in which gain or loss was recognized such that all of the other stock of the owner does not meet the requirements of section 1504(a)(2), such direct acquisition shall be treated as a transaction in which gain or loss was recognized. The principles of this paragraph (b)(4)(iv)(D) will be applied with respect to an indirect acquisition of the owner stock by the SAG.

(E) Acquisitions involving the issuance of subsidiary stock. If a SAG directly or indirectly owns stock of a subsidiary (including a subsidiary SAG member) and the subsidiary directly or indirectly acquires a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business from a person other than such SAG in exchange for stock of such subsidiary in a transaction in which no gain or loss is recognized (the acquisition), solely for purposes of applying this paragraph (b)(4) with respect to the trade or business, partnership interest, or stock acquired by the subsidiary in the acquisition, the subsidiary's stock directly or indirectly owned by the SAG immediately after the acquisition is treated as acquired at the time of the acquisition in a transaction in which gain or loss is recognized.

(F) Acquisitions of controlled stock where controlled is or becomes a DSAG member. With respect to an acquisition of stock in controlled, if controlled is or becomes a DSAG member, paragraph (b)(4)(i)(A) of this section applies and paragraph (b)(4)(i)(B) of this section does not apply for purposes of determining whether the requirements of section 355(b) are satisfied with respect to controlled.

(G) Treatment of stock received in certain tax-free exchanges. Any stock received in a reorganization described in section 368(a)(1)(E) or (F), or in an exchange to which section 1036 applies, in which no gain or loss is recognized is treated as acquired in the same manner as the stock surrendered.

(H) Situations where the separate existence of a subsidiary SAG member is respected. The separate existence of a subsidiary SAG member will be respected for purposes of determining whether a transaction qualifies for nonrecognition treatment under other provisions of the Internal Revenue Code. For example, for purposes of determining whether section 351 applies or whether the transaction qualifies as a reorganization described in section 368(a), the separate existence of the subsidiary SAG member is respected.

(c) Definitions. For purposes of this section the following definitions apply:

(1) Affiliate. An affiliate is any member of an affiliated group as defined in section 1504(a) (without regard to section 1504(b)).

(2) Controlled. Controlled is the controlled corporation.

(3) Distributing. Distributing is the distributing corporation.

(4) Pre-distribution period. The pre-distribution period is the five-year period ending on the date of the distribution.

(d) Conventions and examples —(1) Conventions. The examples in paragraph (d)(2) of this section illustrate section 355(b) and this section. No inference should be drawn from any of these examples as to whether any requirements of section 355 other than those of section 355(b), as specified, are satisfied. Throughout these examples, C, D, D2, P, S, S1, S2, S3, T, X, Y, and Z are corporations, and Partnership is an entity that is treated as a partnership for Federal income tax purposes under § 301.7701-3 of this chapter. Further, assume any transfer described in Examples 1 through 25 that is not identified as a purchase (defined in paragraph (d)(1)(iii) of this section) satisfies all the requirements of paragraph (b)(4) of this section as a transaction in which no gain or loss is recognized. Except as otherwise provided, for more than five years D has owned section 368(c) stock (as defined in paragraph (d)(1)(iv) of this section) but not section 1504(a)(2) stock (as defined in paragraph (d)(1)(v) of this section) of C. Furthermore, the following definitions apply:

(i) ATB. ATB is any active trade or business. ATB1 and ATB2 are not in the same line of business under paragraph (b)(3)(ii) of this section.

(ii) New subsidiary. A new subsidiary is a newly formed wholly owned corporation.

(iii) Purchase. A purchase is an acquisition for cash.

(iv) Section 368(c) stock.Section 368(c) stock is stock constituting control within the meeting of section 368(c).

(v) Section 1504(a)(2) stock.Section 1504(a)(2) stock is stock meeting the requirements of section 1504(a)(2).

(2) Examples. Generally, Examples 1 and 2 illustrate the general requirements in paragraph (a) of this section, Examples 3 through 9 illustrate the SAG rules in paragraphs (b)(1)(ii) and (b)(1)(iii) of this section, Examples 10 through 25 illustrate the rules regarding the active trade or business and active conduct for the pre-distribution period in paragraphs (b)(2) and (b)(3) of this section, Examples 26 through 40 illustrate the acquisition rules in paragraphs (b)(4)(i) through (b)(4)(iii) of this section, and Examples 41 through 51 illustrate the operating rules for acquisitions in paragraph (b)(4)(iv) of this section. The examples are as follows:

Example 1.

Spin-off. For more than five years, D and C have engaged in the active conduct of ATB1 and ATB2, respectively. D distributes the C stock to the D shareholders, and each corporation continues the active conduct of its respective trade or business. Because both D and C are engaged in the active conduct of a trade or business immediately after the distribution and such trades or businesses have been actively conducted by such corporations throughout the pre-distribution period, the requirements of section 355(b) have been satisfied. See paragraphs (a)(1) and (b)(3) of this section.

Example 2.

Split-up. The facts are the same as Example 1 except that D transfers all of its assets (including ATB1) other than the C stock to new subsidiary S, and then distributes the C stock and S stock to the D shareholders. Because C and S are respectively engaged in the active conduct of ATB2 and ATB1 immediately after the distribution, ATB2 has been actively conducted by C throughout the pre-distribution period, and together D (prior to the transfer to S) and S (after the transfer to S) have actively conducted ATB1 throughout the pre-distribution period, the requirements of section 355(b) have been satisfied. See paragraphs (a)(2) and (b)(3) of this section.

Example 3.

Subsidiary SAG member's business. For more than five years, D has owned section 1504(a)(2) stock but not section 368(c) stock of S . Throughout this period, C and S have engaged in the active conduct of ATB1 and ATB2, respectively. In year 8, D distributes the C stock to the D shareholders. Because D owns section 1504(a)(2) stock of S, S is a DSAG member. See paragraph (b)(1)(iii) of this section. D and S are treated as one corporation for purposes of determining whether D is engaged in an active trade or business. See paragraph (b)(1)(ii) of this section. Therefore, D is engaged in the active conduct of ATB2 both throughout the pre-distribution period and immediately after the distribution. Accordingly, D and C both satisfy the requirements of section 355(b).

Example 4.

Additional subsidiary SAG member shares acquired. The facts are the same as Example 3 except that in year 6, D acquires the remaining S stock. D's acquisition of the remaining S stock in year 6 has no effect for purposes of determining whether D satisfies the requirements of section 355(b)(2)(C) because the DSAG is already engaged in the active conduct of ATB2. See paragraph (b)(1)(ii) of this section. Section 355(b)(2)(D) does not apply to D's acquisition of S stock. See paragraph (b)(4)(i)(B) of this section. Accordingly, D and C both satisfy the requirements of section 355(b).

Example 5.

Segmented CSAG business. For more than five years, C has owned all the stock of S1, S2, and S3. Throughout this period, D has engaged in the active conduct of ATB1. Throughout this same period, S1, S2, and S3 have each engaged in a different essential segment of ATB2. While the three segments of ATB2 would together constitute the active conduct of a trade or business, none of S1, S2, or S3 would be considered engaged in the active conduct of an ATB individually. In year 6, D distributes the C stock to the D shareholders. C owns section 1504(a)(2) stock of S1, S2, and S3, therefore, C, S1, S2, and S3 are CSAG members. See paragraph (b)(1)(iii) of this section. C, S1, S2, and S3 are treated as one corporation for purposes of determining whether C is engaged in the active conduct of a trade or business. See paragraph (b)(1)(ii) of this section. Therefore, C is engaged in the active conduct of ATB2 both throughout the pre-distribution period and immediately after the distribution. Accordingly, D and C both satisfy the requirements of section 355(b).

Example 6.

Segmented DSAG business. The facts are the same as Example 5 except that D owns all of the C stock and all of the S3 stock, and D transfers the S3 stock to C immediately prior to the distribution. Prior to D's transfer of the S3 stock to C, D owns section 1504(a)(2) stock of S3 and C, and C owns section 1504(a)(2) stock of S1 and S2, therefore, D, C, S1, S2, and S3 are DSAG members. See paragraph (b)(1)(iii) of this section. D, C, S1, S2, and S3 are treated as one corporation for purposes of determining whether D and C are engaged in the active conduct of a trade or business, and accordingly the transfer of the S3 stock to C is disregarded. See paragraph (b)(1)(ii) of this section. After the transfer, C owns section 1504(a)(2) stock of S3, and the CSAG includes C, S1, S2, and S3. See paragraph (b)(1)(iii) of this section. C, S1, S2, and S3 are treated as one corporation for purposes of determining whether C is engaged in the active conduct of a trade or business. See paragraph (b)(1)(ii) of this section. Throughout the pre-distribution period, D, C, S1, S2, and S3 are treated as one corporation and both D and C are engaged in the active conduct of ATB1 and ATB2. See paragraphs (b)(1) and (b)(2) of this section. Immediately after the distribution, D is engaged in the active conduct of ATB1 and C is engaged in the active conduct of ATB2. Because D and C were engaged in the active conduct of ATB1 and ATB2 throughout the pre-distribution period and, immediately after the distribution, D is engaged in the active conduct of ATB1 and C is engaged in the active conduct of ATB2, D and C both satisfy the requirements of section 355(b).

Example 7.

Failed segmented business. The facts are the same as Example 6 except that D owns section 368(c) stock but not section 1504(a)(2) stock of C. Prior to D's transfer of the S3 stock, the DSAG includes only D and S3, and the CSAG includes only C, S1, and S2. See paragraph (b)(1)(iii) of this section. Therefore, prior to the transfer of the S3 stock, ATB2 does not exist because no one SAG conducts all three of the essential segments of the trade or business. Accordingly, C does not satisfy the requirements of section 355(b) because ATB2 was not actively conducted throughout the pre-distribution period. See paragraph (b)(3)(i) of this section.

Example 8.

Jointly owned partnership. For more than five years, D has owned all of the stock of C, and D and C each have owned a 17-percent interest in Partnership. Throughout this period, D and Partnership have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, D transfers its 17-percent interest in Partnership to C and distributes all of the C stock to the D shareholders. Because D owns section 1504(a)(2) stock of C, C is a DSAG member. See paragraph (b)(1)(iii) of this section. D and C are treated as one corporation for purposes of determining whether D and C are engaged in the active conduct of a trade or business. See paragraph (b)(1)(ii) of this section. Accordingly, throughout the pre-distribution period, D and C are each treated as owning a 34-percent interest in Partnership. As such, both D and C are treated as engaged in the active conduct of both ATB1 and ATB2 throughout the pre-distribution period. See paragraphs (b)(2)(v)(A) and (b)(2)(v)(B) of this section. The transfer of the Partnership interest is disregarded because it is between SAG members. See paragraph (b)(1)(ii) of this section. After the distribution, C owns 34 percent of Partnership and is therefore engaged in the active conduct of ATB2. See paragraphs (b)(2)(v)(A) and (b)(2)(v)(B) of this section. Therefore, D and C both satisfy the requirements of section 355(b).

Example 9.

Sequential application of the SAG rule —(i) Facts. For more than five years, D2 has owned all of the stock of D, and D has owned all of the stock of C. Throughout this period, D2 has engaged in the active conduct of ATB1 and ATB2, and D has engaged in the active conduct of ATB1. C, individually, has not engaged in the active conduct of any ATB. In year 6, D distributes all of the C stock to D2 (first distribution). Immediately thereafter, D2 transfers ATB2 to C and distributes all of the C stock to the D2 shareholders (second distribution).

(ii) Analysis—first distribution. Because D owns section 1504(a)(2) stock of C, C is a DSAG member prior to the first distribution. See paragraph (b)(1)(iii) of this section. D and C are treated as one corporation for purposes of determining whether D and C are engaged in the active conduct of a trade or business with respect to the first distribution. See paragraphs (b)(1)(ii) and (b)(1)(iii) of this section. Accordingly, throughout the pre-distribution period, D and C are each treated as engaged in ATB1 with respect to the first distribution. However, for purposes of determining whether D's distribution of the C stock to D2 satisfies the requirements of section 355(b) immediately after the first distribution, C is the only CSAG member (D2 is not a member of any SAG with respect to the first distribution). See paragraph (b)(1)(iii) of this section. Accordingly, C does not satisfy the requirements of section 355(b) with respect to the first distribution because C is not engaged in the active conduct of an ATB immediately after the first distribution.

(iii) Analysis—second distribution. Because D2 owns section 1504(a)(2) stock of D and C (and D owned section 1504(a)(2) stock of C before the first distribution), D2, D, and C are D2 SAG members throughout the pre-distribution period with respect to the second distribution. See paragraph (b)(1)(iii) of this section. Further, for purposes of the second distribution D's distribution of the C stock to D2 is disregarded because it is between D2 SAG members. See paragraphs (b)(1)(ii) and (b)(1)(iii) of this section. D2, D, and C are treated as one corporation for purposes of determining whether D2 and C are engaged in the active conduct of a trade or business with respect to the second distribution. See paragraphs (b)(1)(ii) and (b)(1)(iii) of this section. Accordingly, throughout the pre-distribution period, D2 and C are each treated as engaged in the active conduct of ATB1 and ATB2 with respect to the second distribution. The transfer of ATB2 to C is disregarded because it is between D2 SAG members. See paragraph (b)(1)(ii) of this section. Immediately after the second distribution, C is engaged the active conduct of ATB2. Therefore, D2 and C both satisfy the requirements of section 355(b) with respect to the second distribution.

Example 10.

Limitations—securities and vacant land. For more than five years, D has owned investment securities and vacant land. D has conducted no activities with respect to the vacant land, but D will subsequently subdivide the vacant land, install streets and utilities, and sell the developed lots to various homebuilders. D cannot currently satisfy the requirements of section 355(b) because the holding of investment securities does not constitute the active conduct of a trade or business. See paragraph (b)(2)(iv)(A) of this section. Furthermore, no significant development activities have been conducted with respect to the vacant land. See paragraph (b)(3) of this section.

Example 11.

Limitations—occupied real estate—active. For more than five years, D, a bank, has owned an eleven-story office building, the ground floor of which D has occupied while engaged in the active conduct of its banking business. The remaining ten floors are rented to various tenants. Throughout this period, the building has been managed, operated, repaired, and maintained by employees of D. D transfers the building along with the significant assets used to operate the building and the goodwill associated with the building to new subsidiary C and distributes the C stock to the D shareholders. Henceforth, C's employees will manage, operate, repair, and maintain the building. D and C both satisfy the requirements of section 355(b). See paragraph (b)(3) of this section.

Example 12.

Limitations—occupied real estate—not active. For more than five years, D, a bank, has owned a two-story building, the ground floor and one half of the second floor of which D has occupied while engaged in the active conduct of its banking business. The other half of the second floor has been rented as storage space to a neighboring retail merchant. D transfers the building and the goodwill associated with the building to new subsidiary C and distributes the C stock to the D shareholders. After the distribution, D leases from C the space in the building that it formerly occupied. Under the lease, D will repair and maintain its portion of the building and pay property taxes and insurance. C does not satisfy the requirements of section 355(b) because it is not engaged in the active conduct of a trade or business immediately after the distribution. See paragraph (b)(2)(iv)(A) of this section. This example does not address the question of whether the activities of D with respect to the building prior to the separation would constitute the active conduct of a trade or business.

Example 13.

No significant activities. For more than five years, D owned land on which it has engaged in the active conduct of the ranching business. Oil has been discovered in the area, and it is apparent that oil may be found under the land on which the ranching business is conducted. D has engaged in no significant activities in connection with its mineral rights. D transfers its mineral rights to new subsidiary C and distributes the C stock to the D shareholders. C will actively pursue the development of the oil producing potential of the property. C does not satisfy the requirements of section 355(b) after the distribution because D was not engaged in significant exploitation activities with respect to the mineral rights throughout the pre-distribution period. See paragraph (b)(3) of this section.

Example 14.

Vertical division—state contracts. For more than five years, D has engaged in the active conduct of a single business of constructing sewage disposal plants and other facilities. D transfers one half of its assets to new subsidiary C. These assets include a contract for the construction of a sewage disposal plant in State M, construction equipment, cash, goodwill, and other tangible and significant assets. D retains a contract for the construction of a sewage disposal plant in State N, construction equipment, cash, goodwill, and other tangible and significant assets. D distributes the C stock to one of D's shareholders in exchange for all of his D stock. D and C both satisfy the requirements of section 355(b). See paragraphs (b)(2) and (b)(3)(i) of this section.

Example 15.

Vertical division—location. For more than five years, D has engaged in the active conduct of owning and operating two men's retail clothing stores, one in the downtown area of the City of G and one in a suburban area of G. D transfers the store building, fixtures, inventory, and other significant assets related to the operations of the suburban store and the goodwill attributable to that store to new subsidiary C. D also transfers to C the delivery trucks and delivery personnel that formerly served both stores. Henceforth, D will contract with a local public delivery service to make its deliveries. D retains the warehouses that formerly served both stores. Henceforth, C will lease warehouse space from an unrelated public warehouse company. D then distributes the C stock to the D shareholders. D and C both satisfy the requirements of section 355(b). See paragraphs (b)(2) and (b)(3)(i) of this section.

Example 16.

Horizontal division—research. For more than five years, D has engaged in the active conduct of manufacturing and sale of household products. Throughout this period, D has maintained a research department for use in connection with its manufacturing activities. The research department has 30 employees actively engaged in the development of new products. D transfers the research department (which has significant assets and goodwill) to new subsidiary C and distributes the C stock to the D shareholders. After the distribution, C continues its research operations on a contractual basis with several corporations, including D. D and C both satisfy the requirements of section 355(b). See paragraphs (b)(2) and (b)(3)(i) of this section. The result is the same if, after the distribution, C continues its research operations but furnishes its services only to D. See paragraphs (b)(2) and (b)(3)(i) of this section. However, see § 1.355-2(d)(2)(iv)(C) (related function device factor) for possible evidence of device.

Example 17.

Horizontal division—sales. For more than five years, D has engaged in the active conduct of processing and selling meat products. D derives income from no other source. D separates the sales function from the processing function by transferring the significant business assets related to the sales function, the goodwill associated with the sales function, and cash for working capital to new subsidiary C. D then distributes the C stock to the D shareholders. After the distribution, C purchases for resale the meat products processed by D. D and C both satisfy the requirements of section 355(b). See paragraphs (b)(2) and (b)(3)(i) of this section. However, see § 1.355-2(d)(2)(iv)(C) (related function device factor) for possible evidence of device.

Example 18.

Expansion and vertical division—location. For more than five years, D has engaged in the active conduct of owning and operating hardware stores in several states. In year 6, D purchased all of the assets of a hardware store in State M, where D had not previously conducted business. In year 8, D transfers the State M hardware store and related significant assets and goodwill to new subsidiary C and distributes the C stock to the D shareholders. After the distribution, the State M hardware store has its own manager and is operated independently of the other stores. Because—

(i) The product of the State M hardware store is similar to the product of D's hardware stores in the other states;

(ii) The business activities associated with the operation of the State M hardware store are the same as the business activities associated with the operation of D's hardware stores in the other states; and

(iii) The operation of a hardware store in State M involves the use of the experience and know-how that D developed in the operation of the hardware stores in the other states, the hardware store in State M is in the same line of business as the hardware stores in the other states. Therefore, the acquisition of the State M hardware store constitutes an expansion of D's existing business and its acquisition does not constitute the acquisition of a new or different business under paragraph (b)(3)(ii) of this section. Accordingly, D and C both satisfy the requirements of section 355(b).

Example 19.

Expansion and horizontal division—Internet. For more than five years, D has engaged in the active conduct of operating a retail shoe store business, under the name D. Throughout this period, D's sales are made exclusively to customers who frequent its retail stores in shopping malls and other locations. D's business enjoys favorable name recognition, customer loyalty, and other elements of goodwill in the retail shoe market. D creates an Internet Web site and begins selling shoes at retail on the Web site. To a significant extent, the operation of the Web site draws upon D's existing experience and know-how. The Web site is named “D.com” to take advantage of the name recognition, customer loyalty, and other elements of goodwill associated with D and the D name and to enhance the Web site's chances for success in its initial stages. Eight months after beginning to sell shoes on the Web site, D transfers all of the Web site's assets and liabilities (all of which include the significant assets and goodwill associated with the Web site's business) to new subsidiary C and distributes the C stock to the D shareholders. The product of the retail shoe store business and the product of the Web site are the same (shoes), and the principal business activities of the retail shoe store business are the same as those of the Web site (purchasing shoes at wholesale and reselling them at retail). Although selling shoes on a Web site requires some know-how not associated with operating a retail store, such as familiarity with different marketing approaches, distribution chains, and technical operations issues, the Web site's operation does draw to a significant extent on D's existing experience and know-how, and the Web site's success will depend in large measure on the goodwill associated with D and the D name. Therefore, the creation by D of the Internet Web site does not constitute the acquisition of a new or different business under paragraph (b)(3)(ii) of this section. Accordingly, it is an expansion of D's retail shoe store business, all of which is treated as having been actively conducted throughout the pre-distribution period. Therefore, D and C both satisfy the requirements of section 355(b).

Example 20.

Expansion—acquiring a SAG member. For more than five years, D has owned all of the stock of C. Throughout this period, C and unrelated T have engaged in the active conduct of ATB1. In year 6, D purchases all of the T stock. In year 8, D distributes all of the C stock to the D shareholders. Throughout the period that C is a DSAG member, D is engaged in the active conduct of ATB1. See paragraph (b)(1)(ii) of this section. Moreover, because D acquired section 1504(a)(2) stock of T, D is treated as having acquired T's assets (and activities), and that acquisition constitutes an expansion of ATB1. See paragraphs (b)(1)(ii) and (b)(3)(ii) of this section. Therefore, D and C both satisfy the requirements of section 355(b). The result would be the same if D had owned all of the T stock for more than five years, and purchased all of the C stock in year 6. See paragraphs (b)(1)(ii), (b)(3)(ii), (b)(4)(i), and (b)(4)(iv)(F) of this section.

Example 21.

No expansion—acquiring only control of controlled. For more than five years, D and unrelated C have engaged in the active conduct of ATB1. In year 6, D purchases section 368(c) stock but not section 1504(a)(2) stock of C. In year 8, D distributes the C stock to the D shareholders. While D and C are in the same line of business, the acquisition does not result in an expansion of D's business under paragraph (b)(3)(ii) of this section because D is not treated as having acquired C's assets (and activities). Accordingly, D has acquired control of C in violation of section 355(b)(2)(D). See paragraph (b)(4)(i)(B) of this section. However, if D acquires additional C stock thereby causing C to become a DSAG member, D would be treated as having acquired C's assets (and activities) and the acquisition would constitute an expansion of ATB1. See paragraphs (b)(1)(ii), (b)(3)(ii), (b)(4)(i), and (b)(4)(iv)(F) of this section. In such a case, D and C both would satisfy the requirements of section 355(b).

Example 22.

Partnership—meaningful but not significant. For more than five years, unrelated X and Y have owned a 20-percent and 33 1/3-percent interest, respectively, in Partnership. The remaining interests in Partnership are owned by unrelated parties. For more than five years, Partnership has manufactured power equipment. But for the performance of all its management functions by employees of X, Partnership would satisfy all the requirements of paragraph (b)(2)(i) of this section. X and/or Y will be attributed the trade or business assets and activities of Partnership only if the corporation satisfies the requirements of paragraph (b)(2)(v)(B) or (b)(2)(v)(C) of this section. See paragraph (b)(2)(v)(A) of this section. While X does not satisfy the requirements of paragraph (b)(2)(v)(B) of this section because X's interest in Partnership is not significant, under paragraph (b)(2)(v)(C) of this section, X owns a meaningful interest in Partnership and performs active and substantial management functions for the trade or business assets and activities of Partnership. Therefore, X is attributed the trade or business assets and activities of Partnership. Accordingly, X is engaged in the active conduct of the business of manufacturing power equipment. See paragraph (b)(2) of this section. In determining whether Y is engaged in the business of manufacturing power equipment, the management functions performed by X for Partnership are not taken into account. See paragraph (b)(2)(v)(A) of this section. Therefore, although Y is attributed Partnership's trade or business assets and activities under paragraph (b)(2)(v)(B) of this section because Y owns a significant interest in Partnership, Y is not engaged in the business of manufacturing power equipment because neither Y nor Partnership perform any management functions for the business. See paragraph (b)(2)(iii) of this section.

Example 23.

Partnership—significant but not meaningful. The facts are the same as Example 22 except that all the management functions related to the business of Partnership are performed by employees of Partnership. Because employees of Partnership perform all of the management functions related to the trade or business assets and activities of manufacturing power equipment, Partnership itself satisfies all the requirements of paragraph (b)(2)(i) of this section. X neither owns a significant interest in Partnership nor performs active and substantial management functions with respect to the trade or business assets and activities of Partnership. Accordingly, X does not satisfy the requirements of paragraph (b)(2)(v)(B) or (b)(2)(v)(C) of this section, X is not attributed the trade or business assets and activities of Partnership's business of manufacturing power equipment, and X is not engaged in the active conduct of the business of manufacturing power equipment. On the other hand, because Y owns a significant interest in Partnership, Y satisfies the requirements of paragraph (b)(2)(v)(B) of this section. Therefore, Y is attributed the trade or business assets and activities of Partnership's business. Accordingly, Y satisfies the requirements of paragraph (b)(2)(i) of this section and is engaged in the active conduct of the business of manufacturing power equipment.

Example 24.

Partnership—significant by many. The facts are the same as Example 23 except that X, Y, and Z each own a 33 1/3-percent interest in Partnership. Because X, Y, and Z each own a significant interest in Partnership, each of X, Y, and Z satisfy the requirements of paragraph (b)(2)(v)(B) of this section. Accordingly, each of X, Y, and Z are attributed the trade or business assets and activities of Partnership, satisfy the requirements of paragraph (b)(2)(i) of this section, and are engaged in the active conduct of the business of manufacturing power equipment.

Example 25.

Non-SAG affiliates —(i) Facts. For more than five years, X has owned 10 percent of the stock of D2, D2 has owned all the stock of D and S, and D has owned all the stock of C. Throughout this period, D has manufactured furniture that it sells to furniture stores and has been the principal owner of the goodwill and significant assets associated with that business and C has owned and operated a laundry business and has been the principal owner of the goodwill and significant assets associated with that business. Throughout this period, however, employees of S have performed all the active and substantial management and operational functions of the furniture business for D and the laundry business for C. D distributes the C stock to D2 (first distribution) and D2 distributes the C stock to X in exchange for all of X's D2 stock (second distribution). After the distributions, employees of X perform all the active and substantial management and operational functions of the laundry business for C that the employees of S performed before the distributions and the employees of S continue to perform the same activities for D as they did before the distributions.

(ii) Analysis—first distribution. In determining whether the furniture manufacturing business and laundry business have been actively conducted throughout the pre-distribution period and immediately after the first distribution, the activities performed for those businesses include activities performed by employees of affiliates of D and C (even if they are not DSAG or CSAG members). Accordingly, such activities include the activities performed by the employees of S for D and C. See paragraph (b)(2)(iii) of this section. D and C own the goodwill and significant assets associated with their respective businesses both throughout the pre-distribution period and immediately after the first distribution, and are treated as performing active and substantial management and operational functions for their respective businesses both throughout the pre-distribution period and immediately after the first distribution. Therefore, D and C both satisfy the requirements of section 355(b) with respect to the first distribution.

(iii) Analysis—second distribution. Because D2 owns section 1504(a)(2) stock of D, C, and S (and D owned section 1504(a)(2) stock of C before the first distribution), D2, D, C, and S are D2 SAG members throughout the pre-distribution period with respect to the second distribution. See paragraph (b)(1)(iii) of this section. Accordingly, D2, D, C, and S are treated as one corporation for purposes of determining whether D2 is engaged in an active trade or business with respect to the second distribution. See paragraph (b)(1)(ii) of this section. Accordingly, for purposes of the second distribution, D2 has been engaged in the furniture manufacturing business and the laundry business throughout the pre-distribution period. Further, for purposes of the second distribution D's distribution of the C stock to D2 is disregarded because it is between D2 SAG members. See paragraph (b)(1)(ii) of this section. D and S continue to be D2 SAG members immediately after the second distribution. See paragraph (b)(1)(iii) of this section. Accordingly, D2 is engaged in the furniture manufacturing business immediately after the second distribution. In determining whether C is engaged in the active conduct of a trade or business immediately after the second distribution, the activities performed for the laundry business include activities performed by employees of affiliates of C (even if they are not CSAG members). Accordingly, immediately after the second distribution, such activities include the activities performed for C by the employees of X. See paragraph (b)(2)(iii) of this section. C owns the goodwill and significant assets associated with the laundry business both throughout the pre-distribution period and immediately after the second distribution, and is treated as performing active and substantial management and operational functions both throughout the pre-distribution period and immediately after the second distribution. Therefore, D2 and C both satisfy the requirements of section 355(b) with respect to the second distribution.

Example 26.

Purchased ATB and SAG member . For more than five years, P has owned all of the stock of D and S1, and D and S1 have owned all of the stock of S2 and S3, respectively. Throughout this period, S1 and S3 have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, S2 purchases ATB1 and all of the S3 stock from S1 on the same day. In year 6, the DSAG acquired ATB1 and ATB2 (as a result of S3 becoming a DSAG member) in a transaction in which gain or loss was recognized. Accordingly, if D were to make a distribution, it could not rely on ATB1 or ATB2 to satisfy the requirements of section 355(b) unless the DSAG's year 6 acquisition of ATB1 and ATB2 is not in the pre-distribution period. See paragraph (b)(4)(i)(A) of this section. The fact that S2 acquired ATB1 and the S3 stock from an affiliate is not relevant.

Example 27.

Purchased ATB prior to entering. For more than five years, T has engaged in the active conduct of ATB1. In year 6, S purchased ATB1 from T. In year 7, D acquired all of the S stock from the S shareholders solely in exchange for D stock in a transaction to which section 351 applied and in which no gain or loss was recognized. As a result, S became a DSAG member. Although S became a DSAG member in a transaction in which no gain or loss was recognized, S, a corporation that later became a DSAG member, acquired ATB1 in a transaction in which gain or loss was recognized. Accordingly, if the D were to make a distribution, it could not rely on ATB1 to satisfy the requirements of section 355(b) unless S's year 6 acquisition of ATB1 is not in the pre-distribution period. See paragraph (b)(4)(i)(A) of this section.

Example 28.

ATB (or new SAG member) for stock of distributing or a corporation in control of distributing in a reorganization—transfer of ATB to controlled. For more than five years, unrelated T and Z have owned all of the stock of X and Y, respectively, and X and Y have engaged in the active conduct of ATB1 and ATB2, respectively. Unrelated P owns all of the stock of D. In year 6, D acquires all of X's assets (including ATB1) from X solely in exchange for D stock in a reorganization described in section 368(a)(1)(A), and all of Y's assets (including ATB2) from Y solely in exchange for P stock in a reorganization described in section 368(a)(1)(A) by reason of section 368(a)(2)(D). No gain or loss is recognized on either acquisition. In a separate transaction, D transfers ATB2 to new subsidiary C in exchange for all of the C stock in a transaction that satisfies the requirements of section 351 and in which no gain or loss is recognized. If D were to distribute the C stock in a separate transaction, D and C can rely on ATB1 and ATB2, respectively, to satisfy the requirements of section 355(b). ATB1 and ATB2 were acquired in transactions in which no gain or loss was recognized, and were not acquired in exchange for assets of the DSAG. See paragraph (b)(4)(ii) of this section. The result would be the same if D acquired all of the assets of T (including the X stock) and Z (including the Y stock) in the reorganizations instead of acquiring the assets of X and Y, and then transferred the Y stock to C. See paragraphs (b)(1)(ii) and (b)(4)(ii) of this section.

Example 29. Taxable transfer of ATB by distributing to controlled.

The facts are the same as the original facts in Example 28 except that before and after the transfer to C, D owned section 368(c) stock but not section 1504(a)(2) stock of C, and recognized gain under section 357(c) gain on the transfer of ATB2 to C. D and C can rely on ATB1 and ATB2, respectively, to satisfy the requirements of section 355(b). See paragraph (b)(4)(iii)(A) of this section. The result would be the same if C purchased ATB2 from D. The result would also be the same if D acquired all of the assets of T (including the X stock) and Z (including the Y stock) in the reorganizations instead of acquiring the assets of X and Y, and then C purchased the Y stock from D. See paragraphs (b)(1)(ii) and (b)(4)(iii)(A) of this section.

Example 30.

Assets for controlled stock in a section 351 transaction. For more than five years, unrelated D and C have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, D transfers trucks to C to be used in ATB2 in exchange for section 368(c) stock of C in a transaction to which section 351 applies and in which no gain or loss is recognized. If D were to distribute the C stock, C could not rely on ATB2 to satisfy the requirements of section 355(b) unless D's year 6 acquisition of the C stock is not in the pre-distribution period because D acquired section 368(c) stock of C, a corporation engaged in ATB2, in exchange for assets not constituting the trade or business. See paragraphs (b)(4)(i)(B) and (b)(4)(ii)(A) of this section. The result would be the same even if C became a DSAG member as a result of the year 6 transfer. See paragraphs (b)(4)(i)(A) and (b)(4)(ii)(A) of this section.

Example 31.

ATB for controlled stock in a reorganization. For more than five years, unrelated D and T have engaged in the active conduct of ATB1 and ATB2, respectively. Throughout this period, D has owned all of the sole class of C stock. In year 6, T merges into C solely in exchange for C stock in a reorganization described in section 368(a)(1)(A) and in which no gain or loss is recognized. As a result, the T shareholders receive 20 percent of the sole class of C stock. Because C acquired ATB2 in exchange for C stock, solely for purposes of determining whether ATB2 can be relied on to satisfy the requirements of section 355(b), D is treated as having acquired its 80 percent of the C stock in year 6 in a transaction in which gain or loss was recognized. See paragraph (b)(4)(iv)(E) of this section. Accordingly, if D were to distribute the C stock, C could not rely on ATB2 to satisfy the requirements of section 355(b) unless C's year 6 acquisition of ATB2 is not in the pre-distribution period because ATB2 was in effect indirectly acquired in exchange for D's assets. See paragraphs (b)(4)(i)(A), (b)(4)(ii)(A), and (b)(4)(iv)(E) of this section.

Example 32.

ATB and controlled stock for distributing stock in a section 351 transaction. For more than five years, T and unrelated C have engaged in the active conduct of ATB1 and ATB2, respectively. Unrelated P owns all of the stock of D. In year 6, P purchases ATB1 from T, and section 368(c) stock of C from the C shareholders. In year 6, P contributes the C stock and ATB1 to D solely in exchange for additional D stock in a transaction to which section 351 applies and in which no gain or loss is recognized. If D were to subsequently distribute the C stock in a separate transaction, D can rely on ATB1, and C can rely on ATB2 to satisfy the requirements of section 355(b) because neither ATB1 nor control of C were acquired in exchange for assets of the DSAG. See paragraphs (b)(4)(i)(A), (b)(4)(i)(B), and (b)(4)(ii) of this section. The fact that P, an affiliate of D, purchased ATB1 and section 368(c) stock of C in year 6 is not relevant.

Example 33.

ATB for distributing stock in a section 351 transaction with section 357(c) gain. The facts are the same as Example 32 except that D has owned section 368(c) stock of C for more than five years, P only purchases ATB1 from T, and P recognizes under section 357(c) gain on the transfer of ATB1 to D as a result of D assuming liabilities of P. D cannot rely on ATB1 to satisfy the requirements of section 355(b) until D's year 6 acquisition of ATB1 is no longer in the pre-distribution period because D acquired ATB1 in a transaction in which gain or loss was recognized. See paragraph (b)(4)(i)(A) of this section.

Example 34.

Partnership distributions. For more than five years, X and Y have engaged in the active conduct of ATB1 and ATB2, respectively. Throughout this period, unrelated D has owned a 90-percent interest in Partnership. D is attributed any trade or business assets and activities of Partnership under paragraph (b)(2)(v) of this section. In year 6, Partnership purchases ATB1 from X and all of the Y stock from its owner. In year 9, Partnership distributes ATB1 and all of the Y stock to D in a non-liquidating distribution. Assume that no gain or loss is recognized by Partnership or any partner on the distribution. As a result of the distribution, Y becomes a DSAG member, and D is treated as having acquired Y's assets (and activities). See paragraphs (b)(1)(ii) and (b)(1)(iii) of this section. If D were to make a distribution, ATB1 could not be relied on to satisfy the requirements of section 355(b) unless Partnership's year 6 acquisition of ATB1 is not in the pre-distribution period. See paragraphs (b)(2)(v), (b)(3)(iii), and (b)(4)(ii)(B) of this section. If D were to make a distribution, ATB2 could not be relied on to satisfy the requirements of section 355(b) unless D's year 9 acquisition of the Y stock is not in the pre-distribution period. See paragraphs (b)(2)(v)(A) and (b)(4)(ii)(B) of this section. Alternatively, if in year 9 Partnership only makes a pro rata distribution of all the Y stock to its partners such that D receives 90 percent of the Y stock, ATB2 cannot be relied on until Partnership's year 6 acquisition of all of the Y stock is no longer in the pre-distribution period. See paragraph (b)(4)(ii)(B) of this section.

Example 35.

Partnership distribution (new SAG member). For more than five years, D has owned a 50-percent interest in Partnership. The remaining interests in Partnership are owned by unrelated parties. Throughout this period, Partnership has engaged in the active conduct of ATB1, and D has been attributed the trade or business assets and activities of Partnership's ATB1 under paragraph (b)(2)(v) of this section. In year 6, pursuant to an integrated plan, Partnership contributes ATB1 to new subsidiary S, and distributes all of the S stock to D in liquidation of D's 50-percent interest in Partnership. Assume that no gain or loss is recognized by Partnership or any partner on the distribution. As a result, S becomes a DSAG member, and D is treated as having acquired S's assets (and activities). See paragraphs (b)(1)(ii) and (b)(1)(iii) of this section. Because D was attributed ATB1 immediately before the incorporation and distribution by Partnership, and S became a DSAG member as a result of the distribution, Partnership's distribution of the S stock to D is not an acquisition of ATB1. See paragraphs (b)(3)(iii) and (b)(4)(ii)(B) of this section. Accordingly, if D were to make a distribution, it can rely on ATB1 to satisfy the requirements of section 355(b).

Example 36.

Transfer of partnership in a reorganization and distributions. For more than five years, T has owned a 40-percent interest in Partnership which has engaged in the active conduct of ATB1. Throughout this period, T has been attributed the trade or business assets and activities of Partnership's ATB1 under paragraph (b)(2)(v) of this section. In year 6, T merges into S, a wholly owned subsidiary of unrelated D, solely in exchange for D stock in a reorganization described in section 368(a)(1)(A) by reason of section 368(a)(2)(D). No gain or loss is recognized. If D were to make a distribution, D can rely on ATB1 because ATB1 has been actively conducted throughout the pre-distribution period, and the interest in Partnership was acquired in a transaction in which no gain or loss was recognized and was not acquired in exchange for assets of the DSAG. See paragraphs (b)(2)(v), (b)(3)(i), and (b)(4)(ii) of this section. The results would be the same if T owned only a 20-percent interest in Partnership, employees of T performed active and substantial management functions for Partnership's trade or business assets and activities prior to the merger, and employees of S (or an affiliate of S) performed active and substantial management functions for Partnership's trade or business assets and activities after the merger. See paragraphs (b)(2)(iii), (b)(2)(v), (b)(3), and (b)(4)(ii) of this section.

Example 37.

Transferred ATB sold (SAG member). For more than five years, D and unrelated T have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, D contributes ATB1 to T in exchange for T stock in a transaction to which section 351 applies. No gain or loss is recognized on the contribution. Immediately after the contribution T is a DSAG member. In year 8, in response to unanticipated market changes, T sells ATB1 to an unrelated third party. Although T became a DSAG member as a result of D acquiring T stock in exchange for ATB1 in a transaction in which no gain or loss was recognized, ATB1 is not the trade or business to be relied upon. Accordingly, D cannot rely on ATB2 until the year 6 transaction is no longer in the pre-distribution period because D acquired ATB2 in exchange for D's assets not constituting the active trade or business to be relied on. See paragraphs (b)(4)(i)(A) and (b)(4)(ii)(A) of this section.

Example 38.

Transferred ATB sold (partnership). The facts are the same as Example 37 except that, in year 6, D and T contribute ATB1 and ATB2, respectively, to Partnership in a transaction to which section 721 applies. In the exchange, D and T each receive a 50-percent interest in Partnership. In year 8, in response to unanticipated market changes, Partnership sells ATB1 to an unrelated third party. If D were to make a distribution, D could not rely on ATB2 under paragraph (b)(2)(v)(B) of this section unless the year 6 transaction is not in the pre-distribution period because D acquired ATB2 in exchange for D's assets not constituting the trade or business to be relied on. See paragraphs (b)(4)(i)(A) and (b)(4)(ii)(A) of this section.

Example 39.

Indirect acquisition of control of distributing's ATB. For more than five years, D and T have engaged in the active conduct of ATB1 and ATB2, respectively. All of the T stock is owned by individuals. In year 6, T purchases all the stock of D in a transaction in which gain or loss is recognized. In a separate transaction, T merges downstream into D solely in exchange for D stock in a reorganization described in section 368(a)(1)(A) and (D). No gain or loss is recognized. In year 7, D transfers ATB2 formerly conducted by T to new subsidiary C, and then distributes the C stock to the D shareholders. Although D acquired ATB2 solely in exchange for D stock in a transaction in which no gain or loss was recognized, the requirements of section 355(b) are not satisfied because ATB1, the business of D, was indirectly acquired by T, a predecessor of D, during the pre-distribution period in a transaction in which gain or loss was recognized. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(A) of this section. The result would also be the same if prior to the year 6 acquisition D and wholly owned subsidiary C were engaged in the active conduct of ATB1 and ATB2, respectively, and T had no ATB.

Example 40.

Exception for corporate distributee. For more than five years, T has owned all of the stock of D which in turn owned all of the stock of C. Throughout this period, D and C have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, P purchases all the stock of T. In year 7, P liquidates T in a transaction in which no gain or loss is recognized under section 332. Under section 334(b), P's basis in the D stock is determined in whole by reference to T's basis in the D stock. In year 8, D distributes the C stock to P. While the D stock was indirectly acquired in a taxable transaction, the adjusted basis that P, the distributee corporation, has in the D stock was determined in whole by reference to T's adjusted basis. Accordingly, D and C satisfy the requirements of section 355(b). See paragraph (b)(4)(iii)(C) of this section. If P were to distribute either the D stock or C stock, neither ATB1 nor ATB2 could be relied on unless the year 6 acquisition of the T stock is not in the pre-distribution period. See paragraph (b)(4)(iii)(C) of this section. The result would be the same if P acquired all of T's assets in exchange for P stock and other property in a reorganization described in section 368(a)(1)(A).

Example 41.

Acquisition of section 368(c) stock of controlled, DSAG member. For more than five years, D has owned section 1504(a)(2) stock but not section 368(c) stock of C. Throughout this period, C has engaged in the active conduct of ATB1. In year 6, D purchased additional shares of C stock. As a result, D acquired section 368(c) stock of C. If D were to make a distribution of the C stock, C could rely on ATB1 to satisfy the requirement of section 355(b). C was a DSAG member, so D was engaged in ATB1 prior to the year 6 purchase of additional C stock. Accordingly, D's acquisition of additional stock of a DSAG member is disregarded in applying paragraph (b)(4)(i)(A) of this section, and paragraph (b)(4)(i)(B) of this section does not apply to this acquisition of additional C stock. See paragraphs (b)(1)(ii) and (b)(4)(iv)(F) of this section.

Example 42.

Controlled becoming a DSAG member. For more than five years, D has owned section 368(c) stock but not section 1504(a)(2) stock of C. Throughout this period, D and C have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, D purchases the remaining C stock. If D distributes all the C stock, C could not rely on ATB2 to satisfy the requirements of section 355(b) because C became a DSAG member (and thus D acquired ATB2) in a transaction in which gain or loss was recognized. See paragraphs (b)(1)(ii), (b)(4)(i)(A), and (b)(4)(iv)(F) of this section.

Example 43.

Nontaxable multi-step acquisition of control. For more than five years, unrelated D and C have engaged in the active conduct of ATB1 and ATB2, respectively. C has two classes of stock outstanding. X owns all 95 shares of the class A stock of C, representing 95 percent of the voting power and 70 percent of the value, and Y owns all of the class B stock of C, representing five percent of the voting power and 30 percent of the value. In year 6, D acquires 10 shares of class A C stock from X in a transaction in which gain or loss was recognized. In year 7, in a separate transaction, D acquires an additional 80 shares of class A C stock from X solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). No gain or loss is recognized. In year 8, in a separate transaction, D acquires the remaining five shares of class A C stock from X in a transaction in which gain or loss was recognized. Because D only acquires 70 percent of the value of C stock, C does not become a DSAG member. In year 9, D distributes the 95 shares of class A C stock to the D shareholders. At the time D first acquired control of C, D owned an amount of C stock constituting control that was acquired in a transaction in which no gain or loss was recognized. Accordingly, D and C both satisfy the requirements of section 355(b). See paragraphs (b)(4)(i)(B) and (b)(4)(iv)(B) of this section.

Example 44.

Taxable multi-step acquisition of control. The facts are the same as Example 43 except that in year 7 D acquires 70 shares of class A C stock solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). No gain or loss is recognized. At the time D first acquired control of C, D did not own an amount of C stock constituting control that was acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the pre-distribution period. Accordingly, C cannot rely on ATB2 to satisfy the requirements of section 355(b) until D's year 6 acquisition of the 10 shares of class A C stock is no longer in the pre-distribution period. See paragraphs (b)(4)(i)(B) and (b)(4)(iv)(B) of this section.

Example 45.

Taxable acquisition of control. For more than five years, unrelated D and C have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, D acquires section 368(c) stock but not section 1504(a)(2) stock of C from unrelated T in a reorganization described in section 368(a)(1)(A) by reason of section 368(a)(2)(E) through the use of a newly created transitory subsidiary of D. In the reorganization, T receives consideration 95 percent of which is D voting common stock and five percent of which is cash. Because D acquired control of C in a single transaction in which gain or loss was recognized, paragraph (b)(4)(iv)(B) of this section does not apply. Accordingly, C cannot rely on ATB2 to satisfy the requirements of section 355(b) until D's year 6 acquisition of control of C is no longer in the pre-distribution period. See paragraph (b)(4)(i)(B) of this section.

Example 46.

Taxable multi-step indirect acquisition of control. For more than five years, C has engaged in the active conduct of ATB1. T owns exactly 80 percent of the total combined voting power of all classes of C stock entitled to vote and 80 percent of the total number of shares of all other classes of C stock, but T owns less than 80 percent of the total value of the C stock. In year 6, unrelated D acquires 10 percent of the sole outstanding class of stock of T in a transaction in which gain or loss is recognized. In year 8, in a separate transaction, T merges into D solely in exchange for D stock in a reorganization described in section 368(a)(1)(A). No gain or loss is recognized. As a result, D owns section 368(c) stock of C. Because D indirectly acquired 10 percent of the C stock owned by T in year 6, at the time D first acquired control of C, D did not own stock constituting control of C that it acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the pre-distribution period. Accordingly, C cannot rely on ATB1 to satisfy the requirements of section 355(b) until D's year 6 acquisition of the T stock is no longer in the pre-distribution period. See paragraphs (b)(4)(i)(B) and (b)(4)(iv)(B) of this section.

Example 47.

Nontaxable multi-step acquisition of SAG member (or ATB). For more than five years, S has engaged in the active conduct of ATB1. X owns all 100 shares of the sole outstanding class of S stock. In year 6, unrelated D acquires 10 shares of S stock from X in a transaction in which gain or loss was recognized. In year 7, in a separate transaction, D acquires an additional 80 shares of S stock from X solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). No gain or loss is recognized. As a result, S becomes a DSAG member. In year 8, in a separate transaction, D acquires another 5 shares of S stock from X in a transaction in which gain or loss was recognized. Because at the time S first became a DSAG member, D owned an amount of S stock meeting the requirements of section 1504(a)(2) that was acquired in a transaction in which no gain or loss was recognized, D can rely on ATB1 to satisfy the requirements of section 355(b) as of the year 7 transaction. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(C) of this section. The acquisition by D of other S stock in a separate transaction in which gain or loss was recognized during the pre-distribution period is disregarded. See paragraph (b)(1)(ii) of this section. The result would be the same if, in year 7, instead of acquiring S stock in a reorganization described in section 368(a)(1)(B), S merged into D in exchange for D stock in a reorganization described in section 368(a)(1)(A) in which no gain or loss was recognized. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(D) of this section.

Example 48.

Taxable multi-step acquisition of SAG member (or ATB). The facts are the same as Example 47 except that in year 6 D acquires 21 shares of S stock in a transaction in which gain or loss was recognized, and in year 7, in a separate transaction, D acquires an additional 79 shares of S stock solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). No gain or loss is recognized, and S becomes a DSAG member. D cannot rely on ATB1 to satisfy the requirements of section 355(b) until D's year 6 acquisition of the 21 shares of S stock is no longer in the pre-distribution period because at the time S first became a DSAG member D did not own an amount of S stock meeting the requirements of section 1504(a)(2) that was acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the pre-distribution period. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(C) of this section. The result would be the same if, in year 7, in a separate transaction, instead of D's acquiring S stock, S merged into D in exchange for D stock in a reorganization described in section 368(a)(1)(A) in which no gain or loss was recognized. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(D) of this section. The result would also be the same if in year 6 D acquired 10 shares of S stock in a transaction in which gain or loss was recognized and, in year 7, in a separate transaction, D acquired an additional 70 shares of S stock solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(C) of this section.

Example 49.

Nontaxable multi-step indirect acquisition using subsidiary stock. For more than five years, X has owned all of the sole outstanding class of S stock. Throughout this period, S and unrelated T have engaged in the active conduct of ATB1 and ATB2, respectively. In year 6, T merges into S solely in exchange for S stock in a reorganization described in section 368(a)(1)(A). No gain or loss is recognized. Immediately after the merger, X and the former T shareholders own 80 percent and 20 percent of the S stock, respectively. In year 8, unrelated D acquires all of the S shares held by X solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B). No gain or loss is recognized. As a result, S becomes a DSAG member. Because D acquired ATB1 and ATB2 in a transaction in which no gain or loss was recognized, solely in exchange for D stock, D can rely on both ATB1 and ATB2 to satisfy the requirements of section 355(b). Because X is neither a predecessor of D nor a DSAG member, paragraph (b)(4)(iv)(E) of this section is not applicable.

Example 50.

Taxable multi-step indirect acquisition using subsidiary stock. The facts are the same as Example 49 except that, for more than five years, D has owned 50 percent of the sole outstanding class of X stock. In year 8, instead of D acquiring the S stock, S merges into D solely in exchange for D stock in a reorganization described in section 368(a)(1)(A). No gain or loss is recognized. Because D indirectly owned S stock and S acquired ATB2 in exchange for S stock, paragraph (b)(4)(iv)(E) of this section is applicable. Under paragraph (b)(4)(iv)(E) of this section, for purposes of applying paragraph (b)(4) of this section with respect to ATB2, D is treated as having indirectly acquired in year 6 the S stock it indirectly owns immediately after the merger of T into S in a transaction in which gain or loss was recognized. Thus, D is treated as having indirectly acquired 40 percent of the S stock in a transaction in which gain or loss is recognized at the time of the merger of T into S. Further, if the merger of T into S is in the pre-distribution period, under paragraph (b)(4)(iv)(D) of this section, D will be treated as having acquired ATB2 in a transaction in which gain or loss is recognized because, immediately before the merger of S into D, D indirectly owned 40 percent of the S stock that had been acquired in a transaction in which gain or loss was recognized. Accordingly, D cannot rely on ATB2 to satisfy the requirements of section 355(b) until the year 6 merger of T into S is no longer in the pre-distribution period. However, D can rely on ATB1 to satisfy the requirements of section 355(b). Alternatively, if X, instead if S, merged into D, S would become a DSAG member and X would be a predecessor of D. If so, for purposes of applying paragraph (b)(4) of this section with respect to ATB2, D is treated as having acquired 80 percent of the S stock in year 6 in a transaction in which gain or loss was recognized. Accordingly, D cannot rely on ATB2 to satisfy the requirements of section 355(b) until the year 6 merger of T into S is no longer in the pre-distribution period. See paragraphs (b)(1)(iii), (b)(4)(i)(A), (b)(4)(iv)(A), and (b)(4)(iv)(E) of this section. However, D can rely on ATB1 to satisfy the requirements of section 355(b).

Example 51.

Taxable multi-step indirect acquisition of SAG member (or ATB). For more than five years, T has engaged in the active conduct of ATB1. Throughout this period, X owned all of the sole outstanding class of T stock, and D owned 50 percent of the sole outstanding stock of S. In year 6, S acquires 50 percent of the sole outstanding class of the X stock in a transaction in which gain or loss is recognized. In year 8, X merges into D solely in exchange for D stock. No gain or loss is recognized. As a result, T becomes a DSAG member. Because D indirectly acquired more than 20 percent of the T stock (D indirectly acquired 25 percent of T) in year 6, at the time T first became a DSAG member D did not own an amount of T stock meeting the requirements of section 1504(a)(2) that it acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the predistribution period. Accordingly, D cannot rely on ATB1 to satisfy the requirements of section 355(b) until D's year 6 indirect acquisition of the T stock is no longer in the pre-distribution period. See paragraphs (b)(4)(i)(A) and (b)(4)(iv)(C) of this section. The result would be the same if, instead of X, in year 8, T merged into D solely in exchange for D stock. See paragraphs (b)(4)(i) and (b)(4)(iv) of this section.