Rev. Rul. 73-472

Advice has been requested as to the applicability of section 351(a) of the Internal Revenue Code of 1954 to the exchanges described below.

Individuals A, B, C, and D each transferred property of equal value to a newly organized domestic corporation solely in exchange for stock and securities of the corporation. Pursuant to the plan, A, B, and C received all of the outstanding stock of the corporation in exchange for their property, and D received solely bona fide indebtedness that constituted securities of the corporation in exchange for his property. The face amount of the securities was equal to the fair market value of the property transferred.

Section 351(a) of the Code provides, in part, that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

Section 368(c) of the Code provides that the term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.

The basic premise of section 351 of the Code is that transfers to controlled corporations only work changes in form, i.e., from direct ownership of property to indirect ownership through a proprietary interest. Hence they are not those types of events calling for the recognition of tax consequences. See S. Rept. No. 275, 67th Cong., 1st Sess. 11-12 (1921). This is inherent in section 368(c) which provides that the term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.

With respect to A, B, and C, no gain or loss will be recognized to them upon the transfer of their properties to the corporation under section 351 of the Code because they maintain a proprietary interest in the property transferred through stock ownership which puts them in control of the corporation within the meaning of section 368(c).

However, section 351 of the Code cannot apply to D inasmuch as D is not part of the "control" group because his ownership of securities is not a measure used by section 368(c) in determining control. Although D is one of the transferors, the ownership of securities representing bona fide indebtedness provides him with no proprietary interest in the corporation, but rather an interest only as a creditor. In LeTulle v. Scofield, 308 U.S. 415, 420 (1940), 1940-1 C.B. 151, it was stated that:

* * * Where the consideration is wholly in the transferee's bonds, or part cash and part such bonds we think it cannot be said that the transferor retains any proprietary interest in the enterprise. On the contrary, he becomes a creditor of the transferee; * * *

Accordingly, gain or loss will be recognized to D upon the exchange of his property solely for securities of the corporation. Such gain or loss will be determined under the provisions of sections 1001 and 1002 of the Code.

Compare Rev. Rul. 73-473, this page, which holds that section 351 of the Code is applicable to a transfer of property to a corporation in exchange solely for securities of the corporation where all of the stock of the corporation is owned by the transferors.