Rev. Rul. 66-365

Advice has been requested whether the payment of cash by an acquiring corporation to the shareholders of the acquired corporation in lieu of issuing fractional shares to the shareholders who are entitled to receive fractional share interests violates the `solely for voting stock' requirement of section 368(a)(1)(B) and (C) of the Internal Revenue Code of 1954. Advice has also been requested concerning the tax treatment of cash received by shareholders in lieu of fractional shares in certain reorganizations defined in section 368(a)(1) of the Code.

In Mills, et al. v. Commissioner , 331 F.2d 321 (1964), reversing 39 T.C. 393 (1962), the United States Court of Appeals for the Fifth Circuit held that the `solely for voting stock' requirement of section 368(a)(1)(B) of the Code was satisfied where the acquiring corporation received all of the stock of several corporations and distributed in return for such stock, shares of its voting common stock and a small amount of cash in lieu of fractional shares. After finding that the cash given in lieu of fractional shares was simply a mathematical rounding-off for the purpose of simplifying the corporate and accounting problems which would have been caused by the actual issuance of fractional shares, the Court concluded that the receipt of the stock of the acquired corporations was for all practical purposes `solely in exchange for voting stock'.

The Internal Revenue Service will follow the decision of the Court of Appeals in Mills, et al. v. Commissioner in similar factual situations. Accordingly, the `solely for voting stock' requirement of section 368(a)(1)(B) and (C) of the Code will not be violated where the cash paid by the acquiring corporation is in lieu of fractional share interests to which the shareholders are entitled, representing merely a mechanical rounding-off of the fractions in the exchange, and is not a separately bargained-for consideration. Where, however, the cash paid by the acquiring corporation is not in lieu of fractional share interests to which the shareholders are entitled or is a separately bargained-for consideration, the `solely for voting stock' requirement of section 368(a)(1)(B) and (C) of the Code will not be satisfied.

In a transaction qualifying as a reorganization under section 368(a)(1)(A) or (D) or (C) by reason of section 368(a)(2)(B) of the Code where the cash paid by the acquiring corporation represents a separately bargained-for consideration it will be treated as the receipt of `boot' under sections 361(b) and 356(a) of the Code. See Tenney Ross v. United States , 173 F.Supp. 793 (1959), in which the cash distributed to the shareholders of the acquired corporation pursuant to a reorganization under section 368(a)(1)(A) of the Code was held to be dividend boot under section 356(a)(2) of the Code where the cash paid did not result in a mere mechanical rounding-off of fractions but was a separately bargained-for consideration. See also Revenue Ruling 56-220, C.B. 1956-1, 191, which holds, in effect, that all of the cash paid to the shareholders of the acquired corporation was separately bargained-for consideration in the exchange. The Revenue Ruling states that the acquiring corporation did not desire to give the stockholders of the acquired corporation a large common stock ownership in itself.

In all reorganizations described in the preceding paragraphs where the cash payment made by the acquiring corporation is not bargained for, but is in lieu of fractional share interests to which the shareholders are entitled, such cash payment will be treated under section 302 of the Code as in redemption of the fractional share interests. There fore, each shareholder's redemption will be treated as a distribution in full payment in exchange for his fractional share interest under section 302(a) of the Code provided the redemption is not essentially equivalent to a dividend. The Mills case is an example of the type of case in which capital gain or loss treatment will be accorded a redemption where cash is paid in lieu of fractional share interests. If the redemption is essentially equivalent to a dividend, it will be treated as a distribution under section 301 of the Code as provided in section 302(d) of the Code. All the facts and circumstances of each case will be considered in determining whether the cash distribution in lieu of the fractional shares is essentially equivalent to a dividend.

The foregoing principles are illustrated by the following example. If, in a reorganization described in section 368(a)(1)(A) of the Code, a shareholder receives stock worth $100 and cash boot of $20, the gain, if any, realized on the exchange, will be recognized under section 356(a) of the Code but not in excess of $20. If the shareholder also receives $4 and it is not bargained for but is in lieu of a fractional share interest, the $4 will be considered as the proceeds from a redemption of the fractional share interest under section 302 of the Code.

If the cash payment made by the acquiring corporation is in lieu of fractional share interests of stock which in section 306 stock, such cash payment will be treated as a distribution in redemption to which section 301 applies unless it is established to the satisfaction of the Commissioner that the distribution of cash was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax. See section 306(b)(4) of the Code.

Revenue Ruling 56-220, C.B. 1956-1, 191, is clarified to remove any implication that the cash paid by the acquiring corporation to the shareholders of the acquired corporation was in lieu of fractional shares, rather than bargained-for additional consideration.