Rev. Rul. 57-278

Advice has been requested whether the reorganization plan herein described qualifies for tax-free treatment under section 368(a) (1)(C) of the Internal Revenue Code of 1954 in view of the principle set forth in Revenue Ruling 54-396, C.B. 1954-2, 147.

In the instant case, two existing corporations and a newly formed corporation were involved in the plan of reorganization. Originally, the parent corporation owned 72 percent of the outstanding capital stock of corporation M . The remaining 28 percent of M's outstanding stock was widely held by the public. For valid business reasons, the parent desired to eliminate the minority interest of corporation M and operate it as a wholly-owned subsidiary.

In order to achieve the desired result, the parent organized a new corporation in a different state and issued to the new corporation a block of its voting stock in exchange for all the stock of the new corporation. In turn, and pursuant to an agreement with the principal minority stockholders of corporation M , the new corporation acquired all of the assets of corporation M in exchange for the stock of the parent corporation. Following this transaction, corporation M distributed to its shareholders the stock of the parent corporation on the basis of one share of the parent corporation's stock for each two share of M corporation's stock.

Corporation M exchanged with the parent 72 percent of that portion of the stock of the parent corporation issued to the new corporation upon organization, the total of which was received by it in exchange for all of its assets, for 72 percent of its own capital stock held by the parent corporation. Corporation M exchanged the remaining 28 percent of the parent company stock held by it with its minority stockholders for the 28 percent of its stock held by them. As a result of all these transactions, the new corporation became a wholly owned subsidiary and corporation M was dissolved.

Section 368(a)(1)(C) of the Internal Revenue Code of 1954, relating to corporate reorganizations, defines a reorganization as `* * * the acquisition by one corporation, in exchange solely for all or part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation * * *.'

Revenue Ruling 54-396, supra , holds that a transaction between two corporations, wherein one, the majority stockholder (but owning less than 80 percent) of the second, acquires all of the assets of the second in exchange for its common stock, is not a nontaxable reorganization within the purview of section 112(g)(1)(C) of the Internal Revenue Code of 1939 (now embodied in section 368(a)(1)(C) of the 1954 Code, since the first corporation, which already owned 79 percent of the second corporation's stock, acquired only 21 percent of the assets of the second corporation through the exchange of stock. The remaining 79 percent of the assets were acquired by the first corporation as a liquidating dividend in exchange for the stock of the second corporation

The question here involved is whether the principle of Revenue Ruling 54-396 should be extended to the new forms of `C' reorganizations allowed under the Internal Revenue Code of 1954, i.e. , where a subsidiary acquires substantially all of the properties of another corporation solely in exchange for its parent's voting stock.

It will be noted that in the instant case the same result would have been achieved if the parent corporation had acquired all of the stock of corporation M solely for its own voting stock in a `B' reorganization (meaning reorganizations under section 368(a)(1)(B) of the 1954 Code) and then caused corporation M to be reincorporated in another state. Under the 1954 Code, a `B' reorganization may occur even though the acquiring corporation already owns a large block of stock of the other corporation. It, therefore, seems that the new form of `C' reorganization acquisition is tax free in a case in which a `B' reorganization acquisition, in a slightly different form, but having almost the same ultimate effect, would be tax free under the statute. Accordingly, Revenue Ruling 54-396, supra , will be restricted to those cases in which the ultimate transferee acquires some of the assets through a liquidation. The transitory ownership of assets by a corporation in a `C' reorganization is in effect to be disregarded. See Helvering v. Raymond I. Bashford , 302 U.S. 454, Ct. D. 1299, C.B. 1938-1, 286; Anheuser-Busch, Inc. et al. v. Helvering , 115 Fed.(2d) 662, cert. denied 312 U.S. 699. In each of these cases, it was held that a transaction was not a tax-free reorganization despite a transitory ownership which would have qualified it as such under the then existing law.

In view of the foregoing, the Internal Revenue Service holds that the acquisition by the new corporation of all the assets of corporation M in exchange solely for stock of the parent corporation constitutes a reorganization within the meaning of section 368(a)(1)(C) of the Internal Revenue Code of 1954. No gain or loss is recognized to the parent, the liquidating corporation, or the new corporation as a result of the exchanges made pursuant to the plan of reorganization. As provided by section 354(a)(1) of the Code, no gain or loss is recognized to the shareholders of corporation M upon the exchange of their stock for stock of the parent corporation. Under section 358, the basis of the parent corporation's stock in the hands of corporation M's shareholders is the same as the basis of corporation M's stock exchanged therefor and, under section 362(b), the basis of the properties of corporation M acquired by the new corporation is the same as that of M corporation. In accordance with section 381(c)(2) of the Code, the earnings and profits of corporation M for the taxable year involved are deemed to have been received by the new corporation as of the closing date of the transfer of the properties of the M corporation.