Rev. Rul. 79-289

Rev. Rul. 79-289

ISSUE

Does section 357(c) of the Internal Revenue Code apply to cause recognition of gain on the assumption of liabilities in excess of adjusted basis in a corporation reorganization within the meaning of section 368(a)(1)(F)?

FACTS

P, a domestic corporation, owns 100 percent of the outstanding stock of X, a corporation organized under the laws of State A. P also owns 99.2 percent of the outstanding stock of Y, a corporation organized under the laws of State B. The remaining stock of Y is owned by E, an individual.

In order to avoid the imposition of franchise taxes newly enacted by State A and State B, a decision was made to reincorporate X and Y in State C. In order to effect the plan, a new corporation (Newco) was formed under the laws of State C. X and Y transferred to Newco all of their assets solely in exchange for voting stock of Newco, and the assumption by Newco, of the liabilities of X and Y in a transaction that qualified as a reorganization within the meaning of section 368(a)(1)(D) and section 368(a)(1)(F) of the Code. E dissented to the plan and received, from Y, the cash value of E's Y stock. Following the transaction, Newco continued unchanged the business activities of the transferor corporations.

The X assets transferred consisted of a plant and equipment with a total adjusted basis of 500x dollars. The liabilities of X assumed by Newco totaled 200x dollars. The Y assets transferred consisted of a plant and equipment with a total adjusted basis of 1,000x dollars. The liabilities of Y assumed by Newco totaled 1,500x dollars.

LAW AND ANALYSIS

The applicable sections of the Code are 368(a)(1)(D), 368(a)(1)(F), and 357(c). Section 368(a)(1)(D) states that the term "reorganization" means a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders, or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356. Section 368(a)(1)(F) states that the term "reorganization" means a mere change in identity, form, or place of organization, however effected.

Section 357 of the Code deals with the assumption of liabilities in the case of certain exchanges, including exchanges under section 368(a)(1)(D). Under section 357(a), the assumption of liabilities on the part of a corporate transferee in connection with a reorganization within the meaning of section 368(a)(1)(D), or the acquisition by the corporate transferee of property subject to a liability in such an exchange, shall not be treated as the receipt of money or other property by the transferor. Section 357(c)(1)(B) provides an exception to the nonrecognition rule of section 357(a) for cases in which the sum of the liabilities assumed in a section 368(a)(1)(D) reorganization plus the amount of liabilities to which the property transferred is subject, exceeds the total adjusted basis of the property transferred pursuant to the reorganization. Under section 357(c), if the sum of the amount of the liabilities assumed, plus the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds the total adjusted basis of the property transferred pursuant to the exchange, then the excess shall be considered as gain from the sale or exchange of a capital asset, or property which is not a capital asset, as the case may be.

Since the adjusted basis of the assets transferred by Y to Newco was 1,000x dollars and the liabilities assumed by Newco totalled 1,500x dollars, the liabilities assumed by Newco exceeded the adjusted basis of the property transferred by 500x dollars.

Rev. Rul. 75-161, 1975-1 C.B. 114, and Rev. Rul. 76-188, 1976-1 C.B. 99, hold that section 357(c)(1) of the Code contains no exception to its application in transactions described in section 351 and section 368(a)(1)(D) even though those transactions also qualify as reorganizations to which section 357(c)(1) does not apply. Rev. Rul. 75-161 involved a reorganization in which all of the assets of a corporation were acquired by a commonly controlled corporation in a statutory merger. The acquired corporation distributed the stock of the acquiring corporation to its shareholders and dissolved. Rev. Rul. 76-188 involved the transfer of all of the business assets of a corporation to a newly formed subsidiary corporation. The transferor corporation remained in existence and did not distribute the stock of the subsidiary to its shareholders.

Rev. Rul. 75-161 and Rev. Rul. 76-188 are distinguishable from the instant case because the transactions described therein do not qualify as reorganizations under section 368(a)(1)(F). Section 357(c) is not applicable to reorganizations described in section 368(a)(1)(F), even though the transaction is also described as another type of reorganization such as section 368(a)(1)(D), because section 368(a)(1)(F) reorganizations are nothing more than a mere change in identity, form, or place of organization and the recognition of gain on such transactions is not intended by section 357(c).

HOLDING

The creation of Newco and the transfer to Newco of the assets of X and Y is a reorganization within the meaning of section 368(a)(1)(D) of the Code because P remains in control of Newco. The transaction also constitutes a mere change in form within the meaning of section 368(a)(1)(F) of the Code. Section 357 does not apply to section 368(a)(1)(F) of the Code. Accordingly, Y recognizes no gain on the transfer of its properties and the assumption of its liabilities by Newco by reason of section 357(c) of the Code.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 75-161 and Rev. Rul. 76-188 are distinguished.