Rev. Rul. 54-396

Advice is requested with respect to the tax consequences for Federal income tax purposes of a transaction between two corporations whereby one acquires all of the properties of the other under circumstances hereinafter described. Advice is further requested relative to the applicability of G.C.M. 21873, C.B. 1940-2, 223, in cases of this kind.

M Corporation owned 79 percent of the outstanding capital stock of N Corporation. This stock had been acquired by M Corporation by a cash consideration in prior years. M and N Corporations entered into an agreement whereby shares of common stock of M were issued in exchange for all the properties and assets of N, subject to its liabilities. N Corporation was liquidated and the shares of M received by it in exchange for its assets were distributed to its stockholders pro rata. Thereafter, the business of both corporations was conducted by M.

The question presented is whether the transaction qualifies as a reorganization under the provisions of section 112(g)(1)(C) of the Internal Revenue Code of 1939.

Section 112(g) of the Code provides in part as follows:

(1) The term `reorganization' means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation, or (C) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of substantially all the properties of another corporation, but in determining whether the exchange is solely for voting stock the assumption by the acquiring corporation of a liability of the other, or the fact that property is subject to a liability, shall be disregarded, or (D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred, or (E) a recapitalization, or (F) a mere change in identity, form, or place of organization, however effected.

In G.C.M. 21873, supra , under facts substantially similar to those herein involved it was held that the transaction between the two corporations constituted a reorganization. However, G.C.M. 21873 was issued under the provisions of the Revenue Act of 1932.

Under the 1932 provisions all mergers and consolidations with appropriate business purpose and continuity of interest were considered reorganizations, and the original counterpart of clauses (B) circumstances presented, the M corporation, of section 112(g)(1) of the Internal Revenue Code were interpreted merely as a liberal modification of the concept of merger and consolidation, expending such concept to include transactions which might not technically qualify as mergers or consolidations but which had the same practical effect. Under the definition of `reorganization' of that act it did not bar an acquisition of stock in another corporation by a corporation having already acquired for cash more than 20 percent of such other corporation's stock.

Under the Revenue Act of 1934, the later revenue acts, and the Internal Revenue Code of 1939, however, it was made clear that, except in cases where clause (A) or clause (D) of section 112(g)(1), supra , is applicable, the question whether an acquisition of stock or assets of another corporation constitutes a `reorganization' must stand or fall on its full compliance with clause (B) or clause (C) of section 112(g)(1), irrespective of the element of merger.

The language of section 112(g)(1)(C) of the Internal Revenue Code, which is controlling in the instant case, defines a reorganization as the acquisition by one corporation, in exchange solely for all or part of its voting stock, of substantially all the properties of another corporation. Under the circumstances presented, the M corporation, already the owner of 79 percent of N Corporation stock, acquired only the remaining 21 percent of the assets of N through the exchange of stock. The remaining 79 percent of the assets were acquired by M as a liquidating dividend in exchange for the stock of N which had been acquired by cash purchase in prior years.

Accordingly, it is held that the transaction in the instant case does not qualify as a reorganization within the purview of section 112(g)(1)(C) of the Internal Revenue Code. It is further held that the minority stockholders effected a taxable exchange within the meaning of section 112(a) of the Code, and a taxable gain or loss resulted to M Corporation upon the liquidation of N as provided in section 115(c) of the Code.

G.C.M. 21873, C.B. 1940-2, 223, is not applicable to transactions consummated within a taxable year beginning after December 31, 1933.