Rev. Rul. 83-38

ISSUE

With regard to a transaction occurring prior to the effective date of section 311(d) and (e) as amended and enacted by the Tax Equity And Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 1982-2 C.B. 462, 500, whether the nonrecognition of gain provisions of section 311(a) and pre-TEFRA section 311(d)(2)(B) of the Internal Revenue Code apply when a parent corporation transfers the appreciated stock of a subsidiary which it wishes to sell and which an unrelated transferee corporation wishes to acquire, in exchange for the parent corporation's stock that was purchased by the transferee corporation immediately prior to the transaction in a public tender offer solely for the purpose of exchanging it for the subsidiary stock.

FACTS

A domestic parent corporation, P, wished to dispose of its wholly-owned subsidiary corporation, S. P also desired, for corporate purposes, to reduce the number of outstanding shares of its common stock. Several potential purchasers, including an unrelated corporation, Z, contacted P to purchase S, and Z's bid was the highest of those submitted. P wished to avoid paying federal income tax on the gain to be realized on the sale of S. Accordingly, P and Z concluded an agreement in an attempt to satisfy P's desire to sell S tax free and to reduce its outstanding shares, and Z's desire to acquire S. Under that agreement, Z would make a public tender offer to holders of P common stock to purchase x shares of that stock. Then, P would exchange 97 percent of its S stock for the x shares of P stock acquired by Z. Finally, Z would purchase for cash the remaining 3 percent of the S stock from P. If Z was unable to purchase x shares of P in the tender offer, so as to enable Z to exchange those shares for 97 percent of the S stock, P agreed to sell all of the remaining shares of S stock to Z for cash.

The terms of the tender offer specified that the offer was not being made by Z to influence or acquire control of the business of P, but solely for the purpose of immediately exchanging all the acquired P shares with P in return for shares of S, pursuant to the prior agreement between P and Z. No dividends on the P stock were due, declared, or paid from the date Z first purchased P stock pursuant to the tender offer to the date Z exchanged this P stock for shares of S stock. This transaction was consummated in 1981.

LAW AND ANALYSIS

Section 61(a)(3) of the Code provides that gross income includes gains derived from dealings in property. Section 1001(a) provides, in part, that the gain from the sale or other disposition of property shall be the excess of the amount realized over the adjusted basis provided in section 1011 for determining gain. Section 1001(c) provides, in general, that all gain or loss will be recognized. Section 311(a) provides, in part, that except as provided in subsection (d), no gain or loss will be recognized to a corporation on a distribution of property with respect to its stock. Section 311(d)(1) provides that a corporation will recognize gain if it distributes appreciated property in redemption of its stock. However, pre-TEFRA section 311(d)(2)(B) provided that the rule of section 311(d)(1) will not apply if the redemption is a distribution of stock of a subsidiary engaged in at least one trade or business, which has not received a substantial part of its assets from the distributing corporation as a capital contribution or in a section 351 exchange within 5 years of the distribution, and at least 50 percent of the outstanding stock of which is owned by the distributing corporation at any time within the 9-year period ending one year before the distribution.

The legislative history of section 311(a) of the Code indicates clearly that section 311(a) is not to apply to a distribution of property made to a shareholder in a capacity other than that of a shareholder. S. Rep. No. 1622, 83d. Cong., 2d Sess. 247 (1954). Similarly, section 1.311-1(e)(1) of the Income Tax Regulations provides that the nonrecognition rules of section 311(a) are limited to distributions made by reason of the corporation-shareholder relationship. Accordingly, section 311(a) does not apply to transactions between a corporation and a shareholder in the capacity of vendee, where the fact that the vendee is a shareholder is incidental to the transaction. Thus, if a corporation receives its own stock as consideration upon the sale of property by it, the resulting gain or loss is recognized by the corporation as though the payment were made in any other property.

In the present situation, section 311(a) of the Code is inapplicable to P's transfer of S stock to Z in exchange for the P stock held by Z because this transfer is not made by reason of a corporation-shareholder relationship between P and Z, but rather is made in P's capacity as a vendor of the S stock. Z acquired the P stock after negotiations between P and Z for the sale by P, and purchase by Z, of S. The acquisition was made pursuant to an agreement arising from those negotiations and represented merely a form of payment, under that agreement, for the S stock sold. Thus, Z's status was created in a sale transaction independent of its transfer of the P stock and outside the context of a corporate-shareholder relationship. Similarly, Z's transfer of the P stock was in settlement of an obligation which arose independently of that transfer and independently of Z's being a shareholder of P. Z had no interest in investing in P stock or in acquiring partial control of P's business. Rather, Z's ownership of P was transitory and was not intended to represent a real shareholder interest. This is clear from the written tender offer and from the fact that, prior to Z's tender offer, P and Z executed a written contract with respect to the subsequent exchange. Accordingly, under section 1.311-1(e) of the regulations, Z's status as a shareholder is incidental to the transaction and section 311(a) is inapplicable.

The form of the transaction was chosen for the purpose of attempting to avoid the tax on the gain which would be recognized to P on the sale of S by qualifying for nonrecognition treatment under section 311(a) of the Code by reason of pre-TEFRA section 311(d)(2)(B). Z had no interest in acquiring a stock ownership in P and did so only to accommodate the tax avoidance motives of P. Z's objective was solely to purchase S, and P's objective with respect to Z was to sell S to Z. Where the form of a transaction is motivated primarily by tax avoidance, the transaction may be recharacterized to accord with its economic substance. Gregory v. Helvering, 293 U.S. 465 (1935), XIV-1 C.B. 193; Waterman Steamship Corp. v. Commissioner, 430 F. 2d 1185 (5th Cir. 1970), cert. denied, 401 U.S. 939 (1971).

The step transaction doctrine generally permits a series of formally separate steps to be amalgamated and treated as a single transaction if they are in substance integrated, inter-dependent, and focused toward a particular end result. Rev. Rul. 79-250, 1979-2 C.B. 156. The two steps of the present transaction were part of a prearranged integrated plan and may not be considered independently for federal income tax purposes. See Rev. Rul. 80-221, 1980-2 C.B. 107, and the cases cited therein, Idol v. Commissioner, 38 T.C. 444, aff'd, 319 F.2d 647 (8th Cir. 1963). See also Bush Brothers and Co. v. Commissioner, 73 T.C. 424 (1979), aff'd, 668 F.2d 252 (6th Cir. 1982).

HOLDING

Section 311(a) and pre-TEFRA section 311(d)(2)(B) of the Code are inapplicable to this transaction, and gain is recognized to P on the exchange of S stock for the P stock purchased by Z, and any cash received from Z, in accordance with section 1001.