ACQUIRING CORPORATION'S PRE-EXISTING STOCK OWNERSHIP INTEREST IN ACQUIRED FIRM WILL NOT PREVENT TRANSACTION FROM QUALIFYING AS TAX-FREE REORGANIZATION

Rev. Rul. 85-107

ISSUES

Whether Rev. Rul. 54-396, 1954-2 C.B. 147, and the decision in Bausch & Lomb Optical Co. v. Commissioner, 30 T.C. 602 (1958), affd, 267 F.2d 75 (2d Cir.), cert. denied, 361 U.S. 835 (1959), are applicable to a transaction that otherwise qualifies as a reorganization under the provisions of section 368(a)(1)(D) of the Internal Revenue Code of 1954.

FACTS

P corporation owned 50 percent of the outstanding stock of T corporation and 80 percent of the outstanding stock of S corporation. The remaining 50 percent of the outstanding stock of T was owned by S. P, S, and T do not make a consolidated return. The T stock was acquired by P and S for cash more than 20 years ago.

Pursuant to a plan of reorganization and for valid business reasons, T transferred all its properties to S in exchange for S voting stock and the assumption by S of the liabilities of T. S's 50 percent stock interest in T was cancelled. The S stock received by T was distributed to P in exchange for its T stock, and T was dissolved. Except for the question here at issue with respect to the application of Rev. Rul. 54-396 and the Bausch & Lomb doctrine, the transaction met all the requirements of section 368(a)(1)(D) of the Code.

LAW AND ANALYSIS

Section 368(a)(1)(C) of the Code provides that the term "reorganization" includes the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of substantially all of the properties of another corporation.

Section 368(a)(1)(D) of the Code provides that the term "reorganization" includes a transfer by a corporation of all its assets to another corporation if immediately after the transfer the transferor, or its shareholders, is in control of the corporation to which the assets are transferred, provided that the stock of the transferee corporation is distributed in a transaction which qualifies under section 354.

For purposes of nondivisive transactions under section 368(a)(1)(D) of the Code, section 368(c)(2), through reference to section 304(c), provides that the term "control" means ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock of the corporation.

Under the provisions of section 354(b) of the Code, the general nonrecognition provisions of section 354(a) apply to a section 368(a)(1)(D) reorganization so long as the transferee corporation acquires substantially all the assets of the transferor and the stock received by such transferor (as well as any other property still held by the transferor) is distributed in pursuance of the plan of reorganization.

In Rev. Rul. 54-396, M corporation, owning 79 percent of the stock of N corporation, acquired all the assets of N in exchange for M voting stock. N was then liquidated and the M stock was distributed to the N shareholders. Rev. Rul. 54-396 holds that the acquisition by M of all the assets of N in exchange for the M stock, followed by the liquidation of N, did not constitute a reorganization under section 112(g)(1)(C) of the Internal Revenue Code of 1939 (the predecessor to section 368(a)(1)(C) of the 1954 Code), since M, in substance, obtained only 21 percent of N's assets in exchange for M stock, the balance being acquired as a liquidating distribution in exchange of M's 79 percent stock interest in N. The transaction therefore did not satisfy the "solely for voting stock" requirement of section 112(g)(1)(C) of the 1939 Code.

The position taken in Rev. Rul. 54-396 was sustained under similar facts in Bausch & Lomb Optical Co. v. Commissioner, decided under the 1939 Code. In Bausch & Lomb, the acquiring corporation owned a majority (but less than 80 percent) of the stock of the acquired corporation. The acquired corporation transferred its assets to the acquiring corporation for voting stock of the acquiring corporation and then went out of existence. The "solely for voting stock" requirement of section 112(g)(1)(C) of the 1939 Code was held not to be satisfied because the effect of the transaction was the acquisition by the acquiring corporation of the assets of the acquired corporation in exchange for voting stock of the acquired corporation held by the acquiring corporation. The Bausch & Lomb opinion on appeal suggests that in a statutory merger in which the acquiring corporation owned stock of the acquired corporation, the pre-existing stock ownership would not prevent the transaction from qualifying as a reorganization described in section 112(g)(1)(A) of the 1939 Code (the predecessor of section 368(a)(1)(A) of the 1954 Code). See also Grede Foundries, Inc. v. United States, 202 F. Supp. 263 (E.D. Wis. 1962), decided under the 1954 Code. Similarly, in the present situation, since the definition contained in section 368(a)(1)(D) of the Code does not include a "solely for voting stock" requirement, the Bausch & Lomb rationale does not apply in determining whether the acquisition of the T assets by S meets the requirements of section 368(a)(1)(D).

HOLDING

Rev. Rul. 54-396 and the decision in Bausch & Lomb Optical Co. v. Commissioner do not apply to a reorganization which otherwise qualifies under the provisions of section 368(a)(1)(D) of the Code.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 54-396 distinguished.