Rev. Rul. 70-108

Advice has been requested whether convertible preferred stock incorporating rights to purchase additional shares of stock upon conversion, qualifies as "solely voting stock" for purposes of section 368(a)(1)(B) of the Internal Revenue Code of 1954.

The shareholders of X corporation entered into an agreement to exchange their shares of stock for voting convertible preferred stock of Y corporation in a transaction designed to qualify as a reorganization defined in section 368(a)(1)(B) of the Code. Each share of Y preferred stock is convertible into one share of Y common stock. In addition, the shareholder has the option, upon conversion of the preferred stock to common stock of Y, to receive one additional share of Y common stock with the payment of 2x dollars.

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 a 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 question presented is whether the right to purchase additional common stock of Y for cash at the time the preferred stock of Y is converted into common stock of Y constitutes property other than solely voting stock within the meaning of section 368(a)(1)(B) of the Code.

In the case of Helvering v. Southwest Consolidated Corporation, 315 U.S. 194 (1942), Ct. D. 1544, C.B. 1942-1, 218, the Supreme Court of the United States said in discussing stock purchase warrants, "Whatever rights a warrant holder may have * * *, he is not a shareholder. * * * His rights are wholly contractual * * * Thus he does not have, and may never acquire, any legal or equitable rights in shares of stock * * * and he cannot assert the rights of a shareholder."

If rights were separately issued as part of the consideration along with the convertible preferred stock, it is clear that under the rationale of the Southwest Consolidated Corporation decision such rights would constitute property other than voting stock. Whether the rights to purchase stock are issued separately or are incorporated in a stock certificate, the nature of such rights remains the same. Furthermore, the fact that such rights are incorporated in a certificate that otherwise represents stock having an equity interest will not alter this conclusion.

Accordingly, the right to purchase stock constitutes property other than voting stock. Therefore, it is held that the acquisition by Y of the stock of X is not a reorganization within the meaning of section 368(a)(1)(B) of the Code. Gain or loss is recognized to the shareholders of X on the exchange of X stock for Y voting convertible preferred stock.