Rev. Rul. 66-23

Advice has been requested whether a statutory merger pursuant to applicable State law constitutes a reorganization as defined in section 368(a)(1)(A) of the Internal Revenue Code of 1954 when a shareholder who owns 60 percent of the outstanding stock of the transferor corporation is subject to a court order to divest itself within 7 years of all of the stock of the transferee corporation received in the merger.

X corporation owned 60 percent of the outstanding shares of Y corporation. The remaining 40 percent of the outstanding Y stock was publicly owned. In 1961, the United States brought suit against X and Y alleging that X's ownership of Y stock was in violation of the antitrust laws. In 1965, a consent decree was entered ordering Y to merge with unrelated Z corporation. In the merger X received 18 percent of the outstanding stock of Z . The former stockholders of Y , other than X , received 12 percent of the outstanding stock of Z . The consent decree ordered X within 7 years to divest itself of all the Z stock which it received in the merger. Under the decree X had the choice of holding the shares of Z or disposing of them in any manner it wished during the 7-year period. At the time of the merger X had no preconceived plan or arrangement for disposing of any of the Z shares it received although it knew that it had to dispose of all the shares within 7 years.

Section 368(a)(1)(A) of the Code provides in part that, for the purposes of parts I, II, and III of subchapter C of chapter 1 of subtitle A of the Code, the term `reorganization' means-`a statutory merger or consolidation.' Among the requisites to a reorganization under the Code is that of a continuity of interest on the part of those persons who, directly or indirectly, were the owners of the enterprise prior to the reorganization. See section 1.368-1(b) of the Income Tax Regulations. The interest continued must be definite and material and must represent a substantial part of the value of the property transferred. See Helvering v. Minnesota Tea Co ., 296 U.S. 378 (1935), Ct. D. 1060, C.B. XV-1, 189 (1936).

In the instant case, X , the indirect owner of the enterprise prior to the reorganization, received only a stock interest in Z , the corporation which continued the enterprise. But, X received the Z stock subject to the court's order to divest itself of the Z stock within 7 years.

Under these circumstances, X received as a result of the merger an interest in Z , the corporation which continued the enterprise. Moreover, over, that interest was stock representing an ownership interest and in the absence of any plan arrangement for disposition of such stock no other person at the time of the merger had any interest in the stock. For a period of 7 years after the merger X had complete discretion to retain the stock or to dispose of it without restriction as to the manner of disposition. Hence at the time of the reorganization and for such period up to 7 years as X sees fit in its complete discretion, X will possess all the benefits and will be subject to all the risks of ownership.

It is the position of the Internal Revenue Service that the continuity of interest requirements of a reorganization can be satisfied where the shareholder of the transferor corporation receives stock of the transferee corporation without any preconceived plan or arrangement for disposing of any of the stock and with unrestricted rights of ownership for a period of time sufficient to warrant the conclusion that such ownership is definite and substantial, notwithstanding that at the time of the reorganization the shareholder is required by a court decree to dispose of the stock before the end of such period. Ordinarily, the Service will treat 5 years of unrestricted rights of ownership as a sufficient period for the purpose of satisfying the continuity of interest requirements of a reorganization.

Further, if in fact X does sell some or all of the Z shares within 5 years of the date of the reorganization, the status of the reorganization will not be affected, since at the time of the reorganization X had no preconceived plan or arrangement for such sales.

Accordingly, since X has 7 years of complete discretion as to whether it will retain or dispose of the Z shares received in the reorganization, the shares received by X are held to represent a continuing interest in the enterprise.