Rev. Rul. 82-34

ISSUE

Advice has been requested regarding whether continuity of business enterprise is a requirement for a recapitalization to qualify as a reorganization under section 368(a)(1)(E) of the Internal Revenue Code.

LAW, ANALYSIS AND HOLDING Section 368(a)(1)(E) of the Code provides that a "recapitalization" is a reorganization. A recapitalization has been defined as a "reshuffling of a capital structure within the framework of an existing corporation." Helvering v. Southwest Consolidated Corp., 315 U.S. 194 (1942), Ct.D. 1544, 1942-1 C.B. 218.

When a shareholder receives stock in a reorganization described in section 368(a)(1) and either before or after the transaction, the principal business assets of the transferor are sold or disposed of, a question arises whether the continuity of business enterprise requirement for a reorganization is satisfied. See sections 1.1002-1(c), 1.368-1(b) and 1.368-1(d) of the Income Tax Regulations.

The purpose of the reorganization provisions is to except from the general rule of recognizing gain or loss certain specifically described exchanges incident to corporate readjustments which effect only a readjustment of continuing interests in property under modified corporate forms. Section 1.368-1(b) of the regulations states that a continuity of the business enterprise under the modified corporate form is required in a reorganization.

Specifically, section 1.368-1(d) of the regulations provides, in general, that the transferee in a corporate reorganization must either (i) continue the transferor's historic business or (ii) use a significant portion of the transferor's historic business assets in a business.

The "continuity of business enterprise" requirement is closely related to the "continuity of shareholder interest" requirement in section 1.368-1(b) of the regulations in that both are concerned with determining whether a transaction involves an otherwise taxable transfer of stock or assets of one corporation to another corporation, as distinguished from a tax-free reorganization, which assumes only a readjustment of continuing interests under modified corporate form. The consideration of whether a transaction involves an otherwise taxable transfer of stock or assets of one corporation to another corporation is not present in a recapitalization because a recapitalization involves only a single corporation. Therefore, Rev. Rul. 77-415, 1977-2 C.B. 311, consistent with several court decisions, concludes that continuity of shareholder interest is not a requirement for a recapitalization to qualify as a reorganization under section 368(a)(1)(E) of the Code. Similarly, continuity of business enterprise is not a requirement for a recapitalization to qualify as a reorganization under section 368(a)(1)(E).