Rev. Rul. 77-22

Advice has been requested whether the "business purpose" requirement of section 1.355-2(c) of the Income Tax Regulations is satisfied in the following transaction that is otherwise qualified under section 355 of the Internal Revenue Code of 1954 and the regulations thereunder.

P corporation, whose stock is widely held, operates a retail lumber yard. S corporation, which has been a wholly owned subsidiary of P for the last 5 years, is engaged in the manufacture of lime and crushed stones for roads.

Credit is essential to the businesses of both P and S. For many years P and S have done business with B Bank, and relied on B as their principal source of credit. B is particularly receptive to the needs of P and S. Until recently, B was able to extend loans to P up to 8x dollars, and to extend loans to S up to 6x dollars. However, B has recently notified P and S that the Comptroller of the Currency has informed B that since P and S are parent-subsidiary, they are allowed only a single borrowing limit of 8x dollars. Because of business conditions, P and S have no source of financing other than B. Due to the dependence of P and S on a substantial amount of credit, the normal operations of P and S have been seriously affected by the single-credit limit. B has also informed P and S that if the parent-subsidiary relationship no longer existed they would be entitled to separate borrowing limits of 8x dollars and 6x dollars, respectively.

Therefore, P proposes to distribute all of the S stock, pro rata, to the P shareholders. This distribution will increase the availability of commercial loans to P and S.

Section 355 of the Code provides for the tax-free distribution by a corporation to its shareholders of the stock of a controlled subsidiary.

Section 1.355-2(c) of the regulations provides that a distribution by a corporation of stock of a controlled corporation will not qualify under section 355 of the Code where carried out for purposes not germane to the business of the corporations, and that the distribution must be incident to a readjustment of corporate structures required by business exigencies.

In order for P and S to enjoy the separate borrowing limits they had enjoyed in recent years, it is necessary to eliminate the parent-subsidiary relationship of P and S.

Therefore, the distribution of the S stock is germane to the business of the corporations. Accordingly, the pro rata distribution by P of the S stock to the P shareholders is supported by a valid business purpose within the contemplation of section 1.355-2(c) of the regulations.