Rev. Rul. 74-295

Advice has been requested whether, in each of the situations described below, the basis provisions of section 334(b)(2) of the Internal Revenue Code of 1954 will apply to a liquidation under section 332, of a subsidiary whose stock was acquired by the parent corporation, in whole or in part, through the exercise of an option.

Section 334(b)(2) of the Code provides, in pertinent part, that the basis of property distributed to a parent corporation, in complete liquidation of a subsidiary under the provisions of section 332, will be the adjusted basis of the stock with respect to which the distribution was made, provided: (1) the parent owns 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, except nonvoting stock which is limited and preferred as to dividends; (2) the parent acquired the requisite 80 percent stock ownership by purchase, as defined in section 334(b)(3), during a 12-month period beginning with the date of the first qualifying purchase; and (3) the distribution of the property is pursuant to a plan of liquidation adopted not more than two years after the date of the purchase of the requisite 80 percent stock ownership.

Section 1.334-1(c)(3)(i) of the Income Tax Regulations provides, in pertinent part, that where the parent acquires the requisite 80 percent stock ownership in a series of purchases within a 12-month period, the two year period within which the parent must adopt the plan of liquidation begins on the day following the date of the specific purchase, within such 12-month period, which resulted in the parent acquiring the requisite 80 percent stock ownership in the subsidiary.

Section 334(b)(3)(C) of the Code, in pertinent part, defines a purchase to exclude stock acquired from a person the ownership of whose stock would, under section 318(a), be attributed to the person acquiring such stock. Section 318(a)(4) provides that if any person has an option to acquire stock, such stock shall be considered as being owned by such person.

Section 1.334-1(c)(6)(iii) of the regulations provides that if a corporation acquires stock pursuant to an option to buy such stock from a person who, without regard to such option, is not a person the ownership of whose stock would be attributable to the acquiring corporation under section 318(a) of the Code, then such stock will be considered to have been purchased on the date the acquiring corporation acquired the option providing the option is exercised on or before the last day of a 12 month period beginning on the day of the earliest purchase of stock (including stock subject to such option) used in determining the applicability of section 334(b)(2). For this purpose, the stock with respect to which the option was exercised will be deemed to have been purchased on the date the option was acquired. Unless section 1.334-1(c)(6)(iii) applies, a corporation holding an option to purchase more than 20 percent of the stock of another corporation cannot "purchase" the requisite 80 percent stock ownership of that corporation.

The application of the above provisions is illustrated by the situations described below. In each situation, the acquiring corporation acquired an option from individual shareholders of the acquired corporation to purchase their stock in the acquired corporation for a fair market value cash consideration. Without regard to the option, the stock ownership of these former shareholders of the acquired corporation was not, under section 318(a) of the Code, attributed to the acquiring corporation.

Situation 1

On June 1, 1969, X corporation acquired an option to purchase 100 percent of the stock of Y corporation which X exercised on April 1, 1970. On September 1, 1971, X adopted a plan for the complete liquidation of Y. Since X exercised the option within the 12-month purchase period referred to in section 1.334-1(c)(6)(iii) of the regulations, the date the option was acquired, June 1, 1969, is considered the date of the purchase of 100 percent of the Y stock. Since the plan of liquidation was adopted more than two years after this date, the provisions of section 334(b)(2) of the Code will not apply to the liquidation. See section 334(b)(1) in regard to basis of the assets received on liquidation of Y.

Situation 2

On June 1, 1969, R corporation acquired an option to purchase 100 percent of the stock of S corporation which R exercised on April 1, 1970. On May 1, 1971, R adopted a plan for the complete liquidation of S. Since R exercised the option within the 12-month purchase period, referred to in section 1.334-1(c)(6)(iii) of the regulations, the date the option was acquired, June 1, 1969, is considered the date of the purchase of 100 percent of the S stock. Since the plan of liquidation was adopted not more than two years after this date, the provisions of section 334(b)(2) of the Code will apply to the liquidation.

Situation 3

On June 1, 1969, M corporation acquired an option to purchase 100 percent of the stock of N corporation which M exercised on July 1, 1970. On August 1, 1970, M adopted a plan for the complete liquidation of N. Since M did not exercise the option within the 12-month purchase period referred to in section 1.334-1(c)(6)(iii) of the regulations, the date the option was exercised, July 1, 1970, is considered the date on which M acquired 100 percent of the N stock. M thus acquired 100 percent of the N stock from a person the ownership of whose stock is attributed to M under the provisions of section 318(a)(4) of the Code. Accordingly, the acquisition is not a purchase as defined in section 334(b)(3) and the provisions of section 334(b)(2) will not apply to the liquidation even though the plan of liquidation was adopted not more than two years after the requisite 80 percent stock ownership was acquired. See section 334(b)(1) in regard to basis of the assets received on liquidation of N.

Situation 4

On June 1, 1969, Q corporation acquired an option to purchase 40 percent of the stock of V corporation which Q exercised on April 1, 1970. On May 15, 1970, Q made a purchase of an additional 45 percent of the stock of V and on May 30, 1970, Q purchased the remaining stock of V (15 percent). Q then adopted a plan for the complete liquidation of V on April 1, 1972. The provisions of section 334(b)(2) of the Code will apply to the liquidation, since (1) Q exercised the option within the 12-month purchase period referred to in section 1.334-1(c)(6)(iii) of the regulations, June 1, 1969, is considered the date on which Q made a purchase of 40 percent of the stock of V, (2) Q acquired the requisite 80 percent stock ownership on May 15, 1970, in a second purchase (both purchases being within a 12 month period), and (3) Q adopted a plan of liquidation not more than two years after May 16, 1970, in accordance with section 1.334-1(c)(3)(i).

Situation 5

On June 1, 1969, T corporation acquired an option to purchase 19 percent of the stock of V corporation which T exercised on July 1, 1970. On April 1, 1971, T made a purchase of the remaining stock of V (81 percent), and on March 1, 1973, T adopted a plan for the complete liquidation of V. Since T did not exercise the option within the 12-month purchase period referred to in section 1.334-1(c)(6)(iii) of the regulations, the date the option was exercised, July 1, 1970, is considered the date on which T acquired 19 percent of the V stock. Under the provisions of section 334(b)(3) of the Code, the acquisition of this 19 percent interest was not a purchase since the acquisition was from a person the ownership of whose stock is attributable to T under section 318(a)(4). However, since T subsequently acquired the requisite 80 percent stock ownership in a purchase on April 1, 1971, and adopted a plan of liquidation not more than two years after this date, the provisions of section 334(b)(2) will apply to the liquidation.

Situation 6

On June 1, 1969, Z corporation acquired an option to purchase 100 percent of the stock of W corporation, within 15 months. The option was allowed to lapse on September 1, 1970. On January 1, 1972, Z made a purchase of 100 percent of the W stock and on May 1, 1973, Z adopted a plan for the complete liquidation of W. The option having lapsed without being exercised, the acquisition of 100 percent of the W stock on January 1, 1972 was a purchase of the requisite 80 percent stock ownership. Since the plan of liquidation was adopted not more than two years after the date of the purchase, the provisions of section 334(b)(2) of the Code will apply to the liquidation.

Situation 7

On June 1, 1969, O corporation made a purchase of 79 percent of the stock of P corporation. On May 1, 1970, O acquired an option, to purchase the remaining 21 percent stock interest in P, which O exercised on July 1, 1970, and on August 1, 1970, O adopted a plan for the complete liquidation of P. Since O did not exercise the option within the 12-month purchase period beginning on June 1, 1969, the day of the earliest purchase used in determining the applicability of section 334(b)(2) of the Code, July 1, 1970, the date the option was exercised is considered the date on which O acquired 21 percent of the P stock. Under the provisions of section 334(b)(3), O is thus considered to have acquired the 21 percent interest from a person the ownership of whose stock is attributed to O under section 318(a)(4) even though the option was exercised two months after it was acquired. Accordingly, since the requisite 80 percent stock ownership was not acquired by purchase during the 12-month purchase period referred to in section 1.334-1(c)(6)(iii) of the regulations, the provisions of section 334(b)(2) will not apply to the liquidation. See section 334(b)(1) in regard to basis of the assets received on liquidation of P.