Rev. Rul. 68-602

Advice has been requested whether section 332 of the Internal Revenue Code of 1954 will apply under the circumstances described below.

S corporation was a wholly owned subsidiary of P corporation. S had sustained operating losses in prior years that resulted in a net operating loss carryover. S was indebted to P in an amount greater than the fair market value of its assets. P desired to avail itself of S's net operating loss carryover under the provisions of section 381 of the Code.

P cancelled the indebtedness owed to it by S and immediately thereafter S transferred all of its assets subject to its liabilities to P pursuant to a plan of complete liquidation.

Section 332(a) of the Code provides that no gain or loss will be recognized on the receipt by a corporation of property distributed in complete liquidation of another corporation. Section 332(b) of the Code describes the circumstances under which a distribution will be considered to be a complete liquidation under section 332(a) of the Code.

Section 1.332-2(b) of the Income Tax Regulations provides that section 332 of the Code applies only to those cases in which the recipient corporation receives at least partial payment for the stock that it owns in the liquidating corporation.

Section 381(a)(1) of the Code provides, in part, that in the case of an acquisition of assets of a corporation in a distribution to which section 332 of the Code applies then, under section 381(c) of the Code, the net operating losses of the distributor corporation may be carried over and deducted from the taxable income of the acquiring corporation.

Revenue Ruling 59-296, C.B. 1959-2, 87, holds that where the acquiring corporation is a creditor of its wholly owned subsidiary in an amount greater than the fair market value of the subsidiary's assets, a distribution of the subsidiary's assets to the parent in complete liquidation of the subsidiary will not be nontaxable under section 332 of the Code since no part of the transfer is attributable to the stock interest of the parent. That Revenue Ruling also holds that the parent corporation is entitled to a bad debt deduction to the extent provided in section 166 of the Code.

Section 1.61-12 of the regulations provides that if a shareholder of a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of such corporation to the extent of the principal of the debt.

Since the step involving the cancellation of the indebtedness from S to P was an integral part of the liquidation and had no independent significance other than to secure the tax benefits of S's net operating loss carryover, such step will be considered transitory and, therefore, disregarded.

By disregarding the cancellation P is considered to have received nothing in payment for its stock interest in S . Accordingly, the transaction is not a `liquidation' within the meaning of section 332 of the Code and the net operating loss of S may not be carried over and availed of by P under section 381 of the Code. See Revenue Ruling 68-359, page 161, this Bulletin, which holds that where the distribution by a subsidiary of all its properties to its parent did not qualify as a liquidation under section 332 of the Code, the parent could not avail itself of the net operating loss of the subsidiary.