Rev. Rul. 68-21

Advice has been requested whether gain to a corporation is recognized upon the distribution of appreciated property in redemption of its own stock under the circumstances described below.

X corporation is engaged in the business of making and holding substantial long-term investments in stock of other corporations, and it does not normally sell these assets. Its own capital stock is publicly held. X corporation's basic investment policy has been to attain control over the affairs of each corporation in which it owns stock and provide sound management which will lead to increased profitability of each controlled corporation and appreciation in each controlled corporation's stock. X corporation owned 20 percent of Y corporation's outstanding stock which represented approximately 30 percent of X corporation's investment assets. X corporation had effective control of Y corporation, the stock of which was also publicly held. The Y corporation stock had almost trebled in market price since X corporation acquired it.

A merger which is contemplated between Y corporation and an unrelated corporation would result in X corporation's ownership of the surviving corporation being significantly reduced so that X would not have effective control over the surviving corporation's affairs. X corporation decided to terminate its investment in Y corporation because of the loss of a control position, the accomplishment of its purpose in developing Y corporation into a strong financial position with a consequent appreciation in Y corporation's stock, and the desire to change its basic investment policy by concentrating its future investments in an industry other than that of Y corporation's industry. After investigating various possibilities for the disposition of the Y corporation stock, X corporation rejected any plan for a sale of the stock as being impractical and decided to distribute its Y corporation stock to its shareholders in redemption of a portion of their stock in X corporation. The Y corporation stock was offered on a pro rata basis to all of X corporation's shareholders, and shareholders owning 35 percent of the stock of X corporation availed themselves of the offer.

Prior to the redemption offer none of X corporation's shareholders agreed to purchase Y corporation stock from X corporation, nor were there any negotiations with specific buyers for the sale of the Y corporation stock.

Section 311(a) of the Internal Revenue Code provides that no gain or loss will be recognized to a corporation on the distribution, with respect to its stock, of property. Section 1.311-1(a) of the Income Tax Regulations provides that the term `distributions with respect to its stock' includes distributions made in redemption of stock. The regulations also provide that nonrecognition will apply regardless of the fact that such property may have appreciated or depreciated in value. Section 1.311-1(e)(1) of the regulations creates an exception to the foregoing by stating that section 311 of the Code is limited to distributions made by reason of the corporation-shareholder relationship, and it will not apply to transactions between a corporation and a shareholder in his capacity as debtor, creditor, employee, or vendee where the fact that such debtor, creditor, employee, or vendee is a shareholder is incidental to the transaction.

The circumstances in this case show that the corporation-shareholder relationship was essential. The fact that one of X corporation's primary purposes in undertaking the redemption was to dispose of the Y corporation stock did not in itself, create a vendor-vendee relationship between X corporation and its shareholders. Accordingly, since the distribution of Y corporation stock was made by reason of the corporation-stockholder relationship, under section 311(a) of the Code no gain or loss is recognized to X corporation on the distribution.