Rev. Rul. 58-383

Advice has been requested whether terminal distributions from an employees' trust, which has been held to meet the requirements of section 401(a) of the Internal Revenue Code of 1954 and to be exempt under section 501(a) of the Code, may be treated as having been made on account of separation from the service and as thus entitled to the long term capital gain treatment provided for by section 402(a)(2) of the Code, where such distributions are incident to a corporate acquisition and statutory merger, as described below, notwithstanding that the employees of the acquired corporation became employees of the corporation surviving the merger.

The M corporation, a manufacturer of household appliances, desiring to acquire the assets and business of the O corporation, a smaller corporation engaged in the manufacture of a major component of the appliances manufactured by the M corporation and other manufacturers, entered into an agreement of merger with the O corporation. The stock of the O corporation was widely held, and the two corporations had been previously unrelated except for business dealings as buyer and seller of the component supplied by O corporation. Under the merger agreement M corporation offered to exchange shares of its voting stock for shares of the outstanding common stock of O corporation, the sole class of stock outstanding, in a stated per share ratio, provided that at least 80 percent of the shares of the O corporation is offered for exchange pursuant to the agreement.

More than the required 80 percent of the stock of O corporation was so offered in exchange, and the agreed exchanges were duly effected. Immediately following its acquisition of stock of the O corporation (constituting control within the meaning of section 368(c) of the Code), the M corporation in accordance with the plan of reorganization took the necessary steps to effect a statutory merger of the O corporation into itself under the law of the state involved. The business previously conducted by the O corporation was continued and all employees of the O corporation were taken over as employees of the M corporation.

The profit-sharing plan and employees' trust established by the O corporation have been held to meet the requirements of section 401(a) of the Code and the trust has been held to be exempt under section 501(a). Since the M corporation made no provisions for continuing the plan, the trust was terminated as of the date of the merger and lump-sum distributions of the participants' interests in the assets of the trust were made at that time.

Distributions under a qualified employees' trust are taxable in accordance with the provisions of section 402(a) of the Code. Paragraph (1) of that section provides, in part, that amounts actually distributed or made available shall be taxable in the year in which received or made available, under section 72 of the Code, except that section 72(e)(3) shall not apply. Section 402(a)(2) of the Code provides that if the total distributions payable under a qualified trust with respect to any employee are paid to the distributee within one taxable year of the distributee on account of the employee's death or other separation from the service, or on account of the employee's death after his separation from the service, the amount of such distribution, to the extent exceeding the amount contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than six months.

In Revenue Ruling 58-94, C. B. 1958-1, 194, where the assets and business of one corporation were acquired by another under an agreement and plan of reorganization within the meaning of section 368(a)(1)(C) of the Code, and terminal distributions under the employees' pension plan and trust of the corporation whose properties had been acquired under the plan were made on account of the transfer of the business to the acquiring corporation, it was held that such distributions to employees taken over by the acquiring corporation were on account of a "separation from the service" of the former employer within the meaning of section 402(a)(2) of the Code and hence qualified for long-term capital gain treatment. That Revenue Ruling reviewed in some detail the legislative history of section 402(a)(2) and section 402(e) of the Code and in the light of that history, reached the conclusion that a corporate liquidation or reorganization which brings about a change in employment relationship in no more than a formal or technical sense, and which does not involve a substantial change in the make-up of employees, does not constitute a "separation from the service" under section 402(a)(2), but that a separation from the service of a corporate employer does occur where a corporate liquidation or reorganization is not itself the cause of termination of the employer's plan but is merely incident to such a change in the ownership of the business as might occur in the case of a noncorporate employer. In Revenue Ruling 58-95, I. R. B. 1958-11, 21, the same rule was applied to reach the conclusion that a separation from the service occurs within the meaning of section 402(a)(2) where the termination of a corporate employer's qualified pension trust is incident to the acquisition of all of its stock by another corporation for cash, in a transaction amounting in substance to a purchase of assets for cash, even though shortly thereafter the acquired corporation is liquidated under section 332(b) of the Code and its employees are taken over by the acquiring corporation.

The instant case differs slightly from the cases dealt with in those Revenue Rulings as to the nature of the acquisition transaction, which involved both a reorganization under section 368(a)(1)(B) of the Code, incident to which the initial exchanges of stock were tax free under section 354(a), and a statutory merger qualifying as a reorganization under section 368(a)(1)(A). Nevertheless, the acquisition of the stock of the O corporation in the instant case in combination with the statutory merger by which that corporation was merged into the M corporation amounted in substance to the acquisition of the assets and business of the O corporation for stock of the M corporation. In substance, therefore, the case is the same as the case dealt with in Revenue Ruling 58-94, supra.

On the facts here presented, it does not matter that the acquisition of the assets of the former employer corporation involved a statutory merger and that for some purposes the corporation surviving in a statutory merger is deemed to be a continuation of the corporation which loses its corporate life in the merger. The question here being one of statutory construction, that rule is of no greater moment for present purposes than the court deemed it to be in deciding an otherwise unrelated question of statutory construction in Libson Shops, Inc. v. Koehler, 353 U. S. 382, at 386, Ct. D. 1809, C. B. 1957-2, 891. Had the facts surrounding the statutory merger been such as were involved in Stanton Brewery, Inc. v. Commissioner, 176 Fed. 2d 573, or Newmarket Manufacturing Co. v. United States, 233 Fed. 2d 493, involving, in the former case, the merger of an operating company into its parent holding corporation and, in the latter, the re-incorporation of a single business in a new state, the problem of statutory construction would differ and the rule in question would be a factor to be considered along with the absence of a real change in ownership of the business.

It is accordingly held that where a corporation takes over the assets, business and employees of another previously unrelated corporation pursuant to a merger agreement involving a tax-free exchange of stock for stock under section 354(a) of the Code, in pursuance of a plan of reorganization under section 368(a)(1)(B) and a subsequent statutory merger within the meaning of section 368(a)(1)(A), pursuant to the same plan, and, coincident with the merger, terminal distributions are made to beneficiaries of a qualified employees' trust of the acquired corporation, such distributions are on account of a separation from the service of the former employer and are entitled to long-term capital gain treatment under section 402(a)(2) of the Code.