Rev. Rul. 59-97

The Internal Revenue Service has been requested to state whether it will adopt the decision of the Tax Court of the United States in the case of Westerhaus Company, et al. v. Commissioner , T.C. Memo 1957-213, relating to the sales of stock of one wholly-owned corporation to another wholly-owned corporation for taxable years applicable to the Internal Revenue Code of 1939.

Under the facts in the Westerhaus case, the taxpayer, owner of all the stock in a corporation, sold some of its shares to another wholly-owned corporation. In subsequent years, the taxpayer sold more shares in wholly-owned corporations to other wholly-owned corporations. In each of the foregoing transactions, the purchasing corporations had accumulated earnings in excess of the purchase price of the shares of stock, and in each instance new certificates of stock were issued. The sales were at the current book values of the stock.

Section 115(a) of the 1939 Code provides, in part, that the term dividend means any distribution made by a corporation to its shareholders, whether in money or other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year, without regard to the amount of earnings and profits at the time the distribution was made. Section 115(g)(1) of the 1939 Code provides, in general, that if a corporation cancels or redeems its stock at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. Under the provisions of section 117 of the 1939 Code, corporate stock which is not held primarily for sale to customers in the ordinary course of business qualifies as a capital asset and any gain or loss on the sale or exchange thereof constitutes a capital gain or loss.

Revenue Ruling 55-15, C.B. 1955-1, 361, holds that where a sale is made by a sole stockholder of his stock in one corporation to another corporation wholly-owned by him, payments received from such sale represents a cash distribution to the taxpayer, taxable as a dividend under section 115(a) of the 1939 Code.

The Tax Court of the United States, relying on the decisions of Emma Cramer, et al v. Commissioner , 20 T.C. 679, and Roger W. Pope et ux. v. Commissioner , T.C. Memo 1956-41, affirmed 239 Fed.(2d) 881, held in the Westerhaus case that the proceeds of the sales of stock of one wholly-owned corporation to another wholly-owned corporation did not constitute dividends within the meaning of section 115(a) and 115(g) of the 1939 Code, but represented proceeds of sales taxable as capital gains.

In view of the decision in the Westerhaus case, the Service now holds that, in factual situations comparable to those involved in the foregoing cases for years to which the 1939 Code applies, proceeds from the sales of stock of one wholly-owned corporation to another wholly-owned corporation represent proceeds of sales taxable as capital gains rather than as dividends, despite the close relationship of the parties and the available earnings and profits.

However, capital gains treatment will continue to be denied in cases where, and to the extent that, the stock is sold at a price in excess of its fair market value, and in cases where there exist other factors indicating that the true import of the transaction is the receipt of ordinary income, by way of dividend or otherwise, rather than the sale of stock. See, for example, Sam Gold et ux. v. Commissioner , T.C. Memo 58-2, and William M. Liddon et ex. v. Commissioner , 22 T.C. 1220, reversed and remanded on other grounds, 230 Fed.(2d) 304, certiorari denied, 352 U.S. 824.

All cases involving this issue for 1954 and subsequent years are covered specifically by section 304 of the Internal Revenue Code of 1954.

Revenue Ruling 55-15, C.B. 1955-1, 361, is hereby revoked.

¹ Based on Technical Information Release 108, dated October 31, 1958.