Rev. Rul. 74-545

Advice has been requested whether the transaction described below qualifies as a reorganization within the meaning of section 368(a)(1)(C) of the Internal Revenue Code of 1954.

Corporation X, a wholly-owned subsidiary of corporation P, transferred substantially all of its assets, consisting principally of stock in certain wholly owned subsidiaries, to Y, a newly formed corporation, solely in exchange for all of the Y stock (67,000 shares) which consisted of a single class of voting common stock. X then distributed this stock to P in exchange for 67,000 of P's 67,200 shares of stock in X. Although X did not engage in the active conduct of a trade or business immediately afterward, it continued in existence, retaining the assets that were not transferred to Y, which consisted of certain receivables, notes, and cash.

Section 368(a)(1)(C) of the Code provides that the term "reorganization" includes the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded.

Since X transferred substantially all of its assets to Y solely in exchange for Y voting stock, the transaction would appear to meet all the requirements for qualification as a reorganization under section 368(a)(1)(C) of the Code.

However, section 368(a)(2)(A) of the Code provides that if a transaction is "described in" both section 368(a)(1)(C) and section 368(a)(1)(D), it will be treated as described only in section 368(a)(1)(D). Therefore, if the transaction under consideration is "described in" section 368(a)(1)(D) within the meaning of section 368(a)(2)(A), it cannot qualify as a reorganization under section 368(a)(1)(C) despite the fact that it meets the literal requirements of that provision.

Section 368(a)(1)(D) of the Code provides that the term "reorganization" includes a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356.

The transaction under consideration meets the first part of this definition. X transferred assets to Y and immediately after the transfer, P a shareholder of X, was in control of Y. However, the transaction cannot qualify as a reorganization under section 368(a)(1)(D) of the Code since the distribution of the Y stock to P by X did not qualify under section 354, 355, or 356. The stock distribution did not qualify under section 354 (with reference to section 368(a)(1)(D)) because X did not distribute all of its remaining assets along with the Y stock as required by section 354(b)(1)(B). Section 355 did not apply to the distribution because X was not engaged in the active conduct of a trade or business immediately after the distribution as required by section 355(b)(1)(A). Section 356 did not apply since that section applies only when a distribution of stock or securities would qualify under section 354 or section 355 but for the fact that property other than qualifying stock or securities was also distributed.

The fact that the transaction does not qualify as a reorganization under section 368(a)(1)(D) of the Code, however, does not mean that it is not "described in" that section within the meaning of section 368(a)(2)(A). Section 368(a)(2)(A) was enacted to deal with divisive transactions, that is, transactions in which one corporation is divided by its shareholders into two or more corporations, and was intended to insure that such transactions would not be able to avoid the requirements of section 355 by qualifying as a reorganization under section 368(a)(1)(C). See S. Rep. No. 1622, 83rd Cong., 2d Sess. 274 (1954), which, with reference to section 368(a)(2)(A), states:

Your committee intends by this rule to insure that the tax consequences of the distribution of stocks or securities to shareholders or security holders in connection with divisive reorganizations will be governed by the requirements of section 355 relating to distribution of stock of a controlled corporation.

In view of this statement, Congress could not have intended that a divisive transaction (such as the transaction under consideration) would be precluded by section 368(a)(2)(A) of the Code from qualifying as a reorganization under section 368(a)(1)(C) only if it actually qualified as a reorganization under sections 368(a)(1)(D) and 355. A conclusion to that effect would render section 368(a)(2)(A) inapplicable to the very type of transaction to which Congress expressly intended it to apply.

In view of the above, it is concluded that Congress intended that a transaction should be considered to be "described in" section 368(a)(1)(D) of the Code within the meaning of section 368(a)(2)(A) if it involves a transfer of assets to a controlled corporation and a distribution of the stock of the transferee corporation to the shareholders of the transferor corporation, regardless of whether such distribution actually qualifies under section 354, 355 or 356.

Accordingly, the transfer by X of substantially all of its assets to Y in exchange solely for Y voting stock and the distribution of the Y stock by X to P is a transaction "described in" section 368(a)(1)(D) of the Code within the meaning of section 368(a)(2)(A). Consequently, it is precluded from qualifying as a reorganization under section 368(a)(1)(C). However, no gain or loss will be recognized to X on the exchange of its assets for Y stock under the provisions of section 351. The distribution by X of the Y stock to P in exchange for part of the X stock held by P is a redemption, within the meaning of section 317(b), and, pursuant to section 302(d), is taxable to P as provided in section 301.