Rev. Rul. 75-321

Advice has been requested whether the distribution of 95 percent of a subsidiary corporation's stock to its parent corporation's shareholders, 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 in various business enterprises, principally through subsidiary corporations. 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. No single shareholder owns 5 percent or more of the outstanding stock of X. However, 11 shareholders each own between 1 percent and 5 percent of the outstanding stock of X and collectively they own approximately 25 percent of the outstanding stock of X.

For valid business purposes, X intends to distribute to its shareholders, with respect to their stock, 95 percent of the stock of Y corporation, one of its wholly owned subsidiaries. Y is engaged in the business of banking and is X's only subsidiary so engaged. Y, as well as each of the other subsidiary corporations of X, has been actively engaged in business for more than 5 years. The business purpose behind the proposed distribution is involuntary in nature in that the applicable Federal banking laws require X to qualify as a bank holding company or to limit its stock ownership in any bank to no more than a 5 per cent interest. X could not readily qualify as a bank holding company because under banking laws X would be required to divest itself of all of its subsidiaries other than Y. Therefore, X was required to divest itself of 95 percent of its stock interest in its wholly owned subsidiary, Y. The proposed distribution will accomplish that result. The business purpose behind the retention of 5 percent of the Y stock by X is to enable X to have assets of sufficient value (the Y stock) to serve as collateral so as to enable X to obtain needed short-term financing for its remaining business enterprise. Several shareholders of Y will hold amounts of Y stock nearly as great as that held by X after the distribution. No securities of Y will be retained by X.

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 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 in the controlled corporation constituting control within the meaning of section 368(c) and if any stock 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 95 percent of the stock of the controlled corporation; (2) retention of a 5 percent stock interest will not enable the distributing corporation to maintain practical control since several shareholders of the controlled corporation, following the distribution, will each own nearly as much stock in the controlled corporation as will be owned by the distributing corporation; and (3) a sufficient business purpose for the retention of the 5 percent interest is shown to exist. Therefore, the facts establish, in the instant case, that the retention by X of 5 percent of the Y stock was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax. The facts also establish that the transaction is not a device for the distribution of earnings and profits within the meaning of section 355(a)(1)(B) of the Code.

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 on the receipt of 95 percent of the Y stock.