Rev. Rul. 75-469

Advice has been requested whether the distribution of all of a subsidiary corporation's stock by its parent corporation, under the circumstances described below, qualifies as a distribution of stock of a controlled corporation under section 355(a) of the Internal Revenue Code of 1954.

X corporation, the stock of which is widely held and publicly traded, is engaged, through its several subsidiaries, in various manufacturing businesses. Each subsidiary has been engaged in an active business for more than 5 years. All of the stock of each subsidiary has been held by X for more than 5 years. Substantially all of the assets of X consist of the stock and securities of such subsidiaries.

Y corporation, a wholly owned subsidiary of X, has been actively engaged in a manufacturing business for 20 years. All of the shares of Y stock were acquired by X in 1971 in a tax-free reorganization under section 368(a)(1)(B) of the Code. All of the shares of Y stock are presently held by a bank as collateral securing a loan to X of 10x dollars that is due in 15 years. The funds borrowed by X were lent to and have been used by Y in the operation of its business.

For the valid business purpose of satisfying the now dissident former Y shareholders whose actions have been injurious to the operations of X, X would like to distribute all of the shares of Y stock to the former Y shareholders in return for all of their shares of X stock. The bank which holds the Y stock as collateral has agreed to release the Y stock for this purpose but only if other collateral is substituted therefor. To satisfy the conditions of the bank for the release of the Y stock, Y will issue a new interest bearing debenture to X in the amount of 10x dollars payable over the next 15 years to evidence the loan by X to Y. The bank has agreed to accept this debenture as collateral for its loan to X and has agreed to release the Y stock as collateral so that X can distribute it to the former Y shareholders. The debenture represents a security within the meaning of section 355(a)(1)(D) of the Code. Furthermore, the transaction is not being used principally as a device for the distribution of earnings and profits of X or Y or both within the meaning of 355(a)(1)(B).

Section 355(a) of the Code and the regulations thereunder provide that if for valid business purposes (1) a corporation distributes to its shareholders, with respect to its stock, solely the stock or securities of a corporation that it controlled immediately before the distribution within the meaning of section 368(c), (2) the transaction is not used principally as a device for the distribution of earnings and profits within the meaning of section 355(a)(1)(B), (3) the requirements of section 355(b), relating to active businesses, are met and (4) the requirements of section 355(a)(1)(D) are satisfied, no gain or loss will be recognized to (and no amount will be includible in the income of) the shareholders on the receipt of such stock.

Section 355(a)(1)(D) of the Code and the regulations thereunder provide, in part, that the distributing corporation must distribute at least an amount of stock and securities in the controlled corporation constituting control within the meaning of section 368(c) and if any stock or securities of the controlled corporation is retained by the distributing corporation, it must be established to the satisfaction of the Commissioner that such retention was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. Section 1.355-2(d) of the Income Tax Regulations provides that the business reasons (as distinguished from the desire to make a distribution of the earnings and profits) which support a distribution of stock and securities of a controlled corporation under section 1.355-2(c) will ordinarily require the distribution of all of the stock and securities.

In the instant case the facts show that: (1) a genuine separation of the corporate entities will be effected since the distributing corporation will distribute all of the stock of the controlled corporation; (2) retention of the controlled corporation's debentures by the bank will not enable the distributing corporation to maintain any practical control over the controlled corporation following the distribution; and (3) a sufficient business purpose for the retention of the debentures exists. Therefore, the facts establish, in the instant case, that the retention by the bank of the debentures was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax.

Accordingly, in the instant case, since all of the requirements of section 355(a) of the Code will be satisfied, no gain or loss will be recognized to (and no amount will be includible in the income of) the shareholders of X (the former Y shareholders) on the receipt of all of the shares of Y stock.

Compare Rev. Rul. 75-321, page 123, this Bulletin, where a distributing corporation distributed 95 percent of the stock of a controlled corporation to its shareholders and retained the remaining 5 percent of the controlled corporations stock to serve as collateral for loans. Rev. Rul. 75-321 holds that the retention by the distributing corporation of 5 percent of the controlled corporation's stock, under all of the facts stated therein, was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax within the meaning of section 355(a)(1)(D) of the Code.