Rev. Rul. 78-441

Advice has been requested whether the merger of one corporation with and into another, which qualified as a reorganization described in section 368(a)(1)(A) of the Internal Revenue Code of 1954, also qualified as a reorganization described in section 368(a)(1)(F) in view of the fact that there was not a complete identity of shareholders and their proprietary interests in the transferor and acquiring corporations.

Corporations Y and Z were each engaged in business as a national bank for a number of years, and each had 10,000 shares of common stock outstanding. Corporation X, a registered bank holding company, owned 9,840 shares and 9,930 shares of the outstanding stock of Y and Z, respectively. In each case, the directors of Y and Z owned an aggregate of 70 shares of the outstanding stock of their respective bank. The directors' stock was owned solely to satisfy the requirements of federal banking laws and had been sold to them by their respective banks in accordance with repurchase agreements, under which each director agreed to sell the shares purchased back to the bank at their original cost upon the termination or other expiration of the director's term of office. The remaining 90 shares of Y stock were held by members of the public who owned no stock in X. X, Y, and Z filed their returns on the basis of the calendar year.

Pursuant to a plan of reorganization and for valid business reasons, Z repurchased all of the shares of its stock held by its directors and merged with and into Y pursuant to the laws of the United States. Thereafter, Y continued to conduct the banking business formerly operated by Z. As a result of the transaction, Y issued additional shares of its stock to X in exchange for all of the outstanding stock of Z.

Section 368(a)(1)(A) of the Code defines a "reorganization" as "a statutory merger or consolidation."

Section 368(a)(1)(F) of the Code defines a "reorganization" as "a mere change in identity, form, or place of organization, however effected."

Section 1.368-1(b) of the Income Tax Regulations provides, in part, that a continuity of interest on the part of those persons who, directly or indirectly, were the owners of the enterprise prior to a reorganization is a prerequisite to a reorganization under the Code. The interest continued must be definite and material and must represent a substantial part of the value of the property transferred. See Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935), XV-1 C.B. 189 (1936).

In Rev. Rul. 66-284, 1966-2 C.B. 115, a publicly-held corporation sought to change its place of organization pursuant to section 368(a)(1)(F) of the Code when shareholders owning less than one percent of its outstanding stock dissented to the transaction and received a cash payment representing the fair value of their stock. All other shareholders participated in the merger and received stock of the new corporation in exchange for the surrender of their stock in the old corporation. Therein, it was held that when a plan of merger is designed only to effect a change in a single corporation's place of organization, the failure of dissenting shareholders owning a total of less than one percent of the outstanding shares to participate in the plan of merger would be considered to be a de minimus change in the corporation's shareholders and its assets as not to disqualify the merger as a reorganization under section 368(a)(1)(F).

In Rev. Rul. 75-561, 1975-2 C.B. 129, the Internal Revenue Service announced that it would follow certain court decisions holding that the combination of two or more commonly-owned operating corporations, or the merger of a wholly-owned subsidiary into its parent qualifying as a liquidation under section 332 of the Code (to which section 334(b)(2) does not apply) and as a reorganization under section 361(a)(1)(F), would qualify as a reorganization within the meaning of section 368(a)(1)(F), provided certain requirements were satisfied. These requirements are:

(1) There must be complete identity of shareholders and their proprietary interests in the transferor and acquiring corporations. In case of a wholly-owned subsidiary-into-parent merger, this requirement will be deemed satisfied when the shareholders and their proprietary interests in the parent do not change as a result of the merger.

(2) The transferor and acquiring corporations must be engaged in the same business activities or integrated activities before the combination; and,

(3) The business enterprise of the transferor and the acquiring corporations must continue unchanged after the combination.

In Movielab, Inc. v. United States, 494 F.2d 693, 699 (Ct. Cl. 1974), a case accepted by the Service in Rev. Rul. 75-561, the United States Court of Claims discussed the continuity of interest requirement as it applies to a reorganization of multiple operating corporations pursuant to section 368(a)(1)(F) of the Code and noted that tion. Further, the United States Tax a de minimis change in stockholdings does not disqualify an inter-corporate transfer of assets as an "F" reorganiza- Court in Rommy Hammes, Inc. v. Commissioner, 68 T.C. 900, 910 (1977), discussed the identity of proprietary interests required for a reorganization pursuant to section 368(a)(1)(F) involving multiple operating corporations. Although the court therein correctly determined that the transaction failed to meet the identity of shareholders and their proprietary interests requirement in spite of the fact that each shareholder of the merged corporations received an equity value in the surviving corporation that was equal to the aggregate equity value of each shareholder's interest in each of the merged corporations, it noted that a reorganization pursuant to section 368(a)(1)(F) may accommodate a de minimis shift in shareholder proprietary interest in an appropriate situation.

In the instant case, with the exception of the changes in proportionate proprietary interest that resulted from the public shareholders' ownership of Y stock, the shareholders of Y and Z owned the same amount of stock in both corporations in the same proportions before and after the merger with no shift in the voting control of Y. Therefore, based on the facts of this case, the Service will consider the change of shareholders that resulted from the addition of the public shareholders of Y who owned less than 1 percent of the outstanding Y stock to participate in the plan of merger and the change in proportionate proprietary interests that resulted solely from that less than 1 percent change to be such a de minimis change in the corporations' shareholders and their proportionate proprietary interests as not to disqualify the merger of Y and Z as a reorganization under section 368(a)(1)(F) of the Code.

In determining whether the shift in proprietary interests amounted to less than 1 percent of the outstanding shares to participate in the plan of merger, the shift was measured against each shareholder's stock in each merging corporation outstanding prior to the merger, without reference to the rules of constructive ownership of stock contained in section 318 of the Code. Further, the directors' ownership of stock in Y and Z was not considered because the directors' shares were held solely to satisfy the requirements of national banking laws and were subject to repurchase agreements.

Accordingly, the merger of Z into Y qualified as a reorganization pursuant to section 368(a)(1)(F) of the Code as well as a merger pursuant to section 368(a)(1)(A).

Rev. Rul. 66-284 is amplified, and Rev. Rul. 75-561 is modified.