Rev. Rul. 69-91

Advice has been requested whether the transaction described below meets the requirements of section 368(a)(1)(B) of the Internal Revenue Code of 1954.

Corporation X entered into an agreement with the shareholders of corporation Y to acquire all of the stock of Y in exchange solely for voting stock of X. Corporation X also agreed with O, an insurance company, which did not own any of the stock of Y, to purchase for cash an entire issue of convertible debentures of Y that O held. The debentures are convertible at any time into the common stock of Y until their due date in 1982.

The debentures, which have all the indicia of valid indebtedness, confer upon the holder no rights or liabilities as a shareholder of Y unless and until the holder exercises the conversion privilege.

Pursuant to agreement between X and O, O will not exercise the conversion privilege of the debentures prior to the actual purchase by X. Such purchase is conditioned upon the simultaneous acquisition by X of all the stock of Y. After the date of purchase, X intends to hold the debentures until their maturity.

Section 368(a)(1)(B) of the Code provides in part that the term "reorganization" means the acquisition by one corporation, in exchange solely for all or part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition).

The Supreme Court of the United States, in Helvering v. Southwest Consolidated Corporation, 315 U.S. 194 (1942), Ct. D. 1544, C.B. 1942--1, 218, held that contract rights to purchase stock in the form of stock warrants did not constitute voting stock for purposes of section 112(g)(1) of the Revenue Act of 1934, which corresponds in pertinent part to section 368(a)(1) of the Internal Revenue Code of 1954. The opinion states:

"* * * [T]he warrants which were issued were not 'voting stock.' Whatever rights a warrant holder may have 'to require the obligor corporation to maintain the integrity of the shares,' covered by the warrants * * * he is not a shareholder. * * * His rights are wholly contractual. As stated by Holmes, J., in Parkinson v. West End Street Ry. (173 Mass., 446, 448), he 'does not become a stockholder by his contract in equity any more than at law.' * * * If at the time he exercises his right there are no authorized and unissued shares to satisfy his demand, he will get damages not specific performance. * * * Thus he does not have, and may never acquire, any legal or equitable rights in shares of stock. * * * And he can not assert the rights of a shareholder" 315 U.S. at 200-01.

Southwest Consolidated did not involve convertible debentures. However, the opinion does refer to such securities in comparing them to warrants. The opinion states:

"And it makes no difference that in the long run the unexercised warrants expired and nothing but voting stock was outstanding. The critical time is the date of the exchange. In that posture of the case it is no different than if other convertible securities had been issued, all of which had been converted within the conversion period" 315 U.S. at 201.

Since the convertible debentures of Y do not confer upon the holder any rights or liabilities as a shareholder prior to the conversion of the debentures into stock of Y, such debentures resemble the warrants described in Southwest Consolidated. Therefore, the rationale of that decision is applicable to the present case. See also Commissioner v. Neustadt Trust et al., 131 F. 2d 528 (1942), which treated convertible debentures as securities rather than as stock for purposes of section 112(g)(1)(E) of the Revenue Act of 1936, which corresponds to section 368(a)(1)(E) of the 1954 Code.

Accordingly, the convertible debentures do not constitute stock of Y for purposes of section 368(a)(1)(B) of the Code. Furthermore, under the facts described, X's purchase of the debentures for cash from O will not constitute additional consideration for the acquisition of the stock of Y. Therefore, since the stock of Y will be acquired solely in exchange for voting stock of X, the transaction meets the requirements of section 368(a)(1)(B) of the Code.