Rev. Rul. 57-114

Advice has been requested as to the tax effect of a transaction in which corporation O was merged into parent corporation M , after which M distributed the stock of its wholly-owned subsidiary, S , to one of its stockholders in exchange for all of his stock of the parent corporation M issued to him in the merger.

An individual, A , owned one-half of the capital stock of a parent corporation, M , worth 10 x dollars and one-half of the capital stock of corporation O worth 5 x dollars. B , another individual, owned the other half of the parent corporation M stock and B's mother owned the other half of the O corporation stock. Corporation M was the parent of corporation S and owned all of its stock, which is worth 15 x dollars.

For bona fide business reasons, corporation O was merged into corporation M in pursuance of a plan of statutory merger, and additional shares of M stock were issued to the stockholders of the merged corporation O in exchange for their O stock. Individual A then owned one-half of the parent corporation M stock, worth 15 x dollars. Immediately after the merger, the parent corporation distributed all of the stock of its subsidiary corporation S to individual A in exchange for all of the stock of the parent corporation M then owned by him.

Since, immediately after the exchange by individual A of his stock of the merged corporation O for new stock of the parent corporation M , he surrendered all of his newly acquired stock of the parent corporation back to it, such exchange is disregarded for Federal income tax purposes. In effect, therefore, the parent corporation M transferred one-third of the stock of its subsidiary corporation S to individual A in exchange for his stock of the merged corporation O and distributed the remaining two-thirds of the stock of its subsidiary S to A in exchange for his original holding of stock in the parent corporation M .

In view of the foregoing, the Internal Revenue Service holds as follows:

(1) Gain or loss is recognized to both individual A and the parent corporation M on the exchange of all of the stock of the merged corporation O for one-third of the stock of the subsidiary corporation S . See section 1002 of the Internal Revenue Code of 1954.

(2) The distribution by the parent corporation M of two-thirds of its subsidiary S stock to individual A in exchange for his original stock of the parent corporation M does not qualify as a nontaxable distribution under section 355(a)(1) of the Code, since the shares of the subsidiary S so distributed do not constitute control within the meaning of section 368(c). Therefore, the distribution is treated as full payment in exchange for individual A's stock of the parent corporation M under section 305(b)(3) and 302(a) of the Code, and gain or loss is recognized to him under section 1002 of the Code. No gain or loss is recognized to the parent corporation M as a result of the distribution, by virtue of section 311(a) of the Code.

(3) No gain or loss is recognized to either the merged corporation O or the parent corporation M as a result of the merger of O M . See sections 361(a) and 1032 of the Code.

(4) Under the provisions of section 354(a)(1) of the Code, no gain or loss is recognized to B's mother upon the exchange, pursuant to the merger, or her stock in the merged corporation O for stock of the parent corporation M . Likewise, no gain or loss is recognized to individual B as a result of the merger.