Rev. Rul. 69-6

Advice has been requested whether, under the facts outlined below, the acquisition of all of the assets and liabilities of a state chartered savings and loan association having outstanding capital stock, by a federally chartered nonstock savings and loan association constitutes a reorganization under either section 368(a)(1)(A) or section 368(a)(1)(C) of the Internal Revenue Code of 1954.

X is a state chartered savings and loan association having permanent shares of stock outstanding. The stock of X has a fair market value of 25x dollars per share. It proposes to merge, under the laws of its state of incorporation and of the United States, into Y, a federally chartered nonstock membership savings and loan association owned entirely by its share account holders. The share accounts are evidenced by passbooks in the association. Each X shareholder who consents to the merger will exchange his stock for a voting membership in the form of a voting share account of Y evidenced by a passbook in an amount equal to the number of his shares in X multiplied by 25x dollars. Following the merger, X will be dissolved. Both X and Y are domestic building and loan associations within the meaning of section 7701(a)(19) of the Code.

Section 368(a)(1)(A) of the Code provides that the term "reorganization" includes a statutory merger or consolidation. Section 368(a)(1)(C) of the Code describes a reorganization as the acquisition by one corporation, "in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation)," of substantially all the properties of another corporation.

The courts in interpreting the above sections of the Code have held that an otherwise qualified transaction does not constitute a reorganization within the meaning of the Code or prior revenue acts unless those persons who were shareholders prior to the transaction have a substantial continuing proprietary interest in the enterprise after the transaction. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462 (1933), Ct. D. 630, C.B. XII-1, 161 (1933); Minnesota Tea Co. v. Helvering, 302 U.S. 609 (1938), Ct. D. 1305, C.B. 1938-1, 288; section 1.368-1(b) of the Income Tax Regulations. The continuity of interest requirement, under which the owners of an acquired corporation must receive a substantial proprietary or equity interest in the acquiring corporation, is necessary in order to distinguish sales transactions from reorganizations. LeTulle v. Scofield, 308 U.S. 415 (1940), Ct. D. 1432, C.B. 1940-1, 151.

The continuing proprietary interest of the owners of the transferor in the assets of the transferee must represent a substantial part of the value of the property transferred. See Southwest Natural Gas Co. v. Commissioner, 189 F. 2d 332 (5th Cir. 1951), certiorari denied, 342 U.S. 860, where the fact that less than one percent of the total consideration received by the transferor consisted of stock of the transferee disqualified the transaction as a merger under section 112(g)(1)(A) of the Internal Revenue Code of 1939.

In the instant case it is necessary to ascertain the nature of the consideration to be received by the shareholders of X in exchange for their stock. Y's entire equity interest, including the right to vote on matters affecting Y, the right to share in current earnings and the right to share in its assets upon liquidation, is vested in the share account holders who, as members of Y, own passbooks evidencing their interests. The rights of a share account holder in a federally chartered mutual association include a proprietary interest. See sections 7701(a)(7) and (8) of the 1954 Code; Rev. Rul. 54-624, C.B. 1954-2, 16.

However, Revenue Ruling 66-290, C.B. 1966-2, 112, holds that for purposes of section 1.334-1(c)(4)(v) of the regulations dealing with the allocation of basis to assets received in certain liquidations the phrase "cash and its equivalent" includes share accounts in savings and loan associations. Thus, share accounts in a Federal association also include cash equivalents in the face amounts of the account balances. See section 1.451-2 of the regulations dealing with amounts credited to the accounts of shareholders of savings and loan associations.

Consequently, the members of a Federal nonstock mutual association have a dual relationship to the association: (1) as members of a mutual association they possess proprietary interests therein, and (2) as share account holders they possess withdrawable deposits which are the equivalent of cash.

In the instant case Y's obligation to deliver cash deposits to X's shareholders is not severable from its obligation to deliver them a proprietary interest. Both the cash equivalents and the proprietary interests are evidenced by passbooks. The X shareholders will receive passbooks having withdrawable amounts equal to the fair market value of the stock surrendered. Only minimal value can be assigned the proprietary interests in Y received by the X shareholders inasmuch as the principal property received by them consists of withdrawable cash deposits as reflected by their passbook balances. Since their rights as members are insignificant in value as compared to the cash equivalent received by the X shareholders, the passbooks distributed to them do not constitute solely "stock" within the meaning of section 368(a)(1)(C) of the Code, nor is there a sufficient continuity of interest on the part of the X shareholders to qualify the transaction as a reorganization within the meaning of section 368(a)(1)(A) of the Code.

The transfer by X of all of its assets to Y will be considered a sale by X of all of its assets to Y. See section 1.368-1(b) of the regulations which provides in part that a sale is nevertheless to be treated as a sale even though the mechanics of a reorganization have been set up.

Since X will be dissolved, the withdrawable share accounts as represented by the passbooks will be distributed to the X shareholders in complete liquidation of X. Corporation X may avail itself of the provisions of section 337 of the Code if the liquidation meets the requirements of that section.

Section 331(a)(1) of the Code states that amounts distributed in complete liquidation of a corporation will be treated as in full payment in exchange for the stock.

Accordingly, the transfer by X of all of its assets to Y constitutes a sale on which gain or loss will be recognized to X measured by the difference between the basis of the property transferred and the amount received from Y. (See section 337 of the Code for circumstances under which gain may not be recognized). The withdrawable share accounts distributed to the shareholders of X as represented by the passbooks of Y will be treated as in full payment in exchange for their stock of X as provided in section 331(a)(1) of the Code. Gain or loss will be realized by each shareholder measured by the difference between the balance shown in his passbook account and the cost or other basis of the stock of X surrendered. Such gain or loss will represent capital gain or loss and will be taxable as provided in Subchapter P of Chapter 1 of the Code provided the stock of X constitutes a capital asset in the hands of such shareholder.

To the extent X's additions to its reserves for bad debts resulted in a tax benefit for prior years, the balance in such reserves must be included by it in gross income for the final taxable year of its existence. See West Seattle National Bank of Seattle v. Commissioner, 33 T.C. 341 (1959), affirmed 288 F. 2d 47 (1961); Arcadia Savings & Loan Association v. Commissioner, 300 F. 2d 247 (9th Cir. 1962); Citizens Federal Savings & Loan Association of Cleveland v. The United States, 290 F. 2d 932 (1961); Revenue Ruling 65-258, C.B. 1965-2, 94; Revenue Ruling 62-128, C.B. 1962-2, 139; Revenue Ruling 57-482, C.B. 1957-2, 49.

In computing the balance of X's reserves for bad debts that must be restored to income at the close of its final taxable year, X may take into account amounts charged to the reserves during the course of the taxable year pursuant to the specific orders of the supervisory authorities having jurisdiction over its operations.

Section 166 of the Code provides for the deduction of bad debts for income tax purposes and section 593 of the Code sets forth the manner in which X, and other taxpayers described in section 593 of the Code, compute income tax reserves for losses on loans. Section 1.166-2(d) of the regulations contains a provision that is applicable to X as follows:

"Banks and other regulated corporations--(1) Worthlessness presumed in year of charge-off. If a bank or other corporation which is subject to supervision by Federal authorities, or by State authorities maintaining substantially equivalent standards, charges off a debt in whole or in part in obedience to the specific orders of such supervisory authorities, then the debt shall, to the extent charged off during the taxable year, be conclusively presumed to have become worthless, or worthless only in part, as the case may be, during such taxable year. But no such debt shall be so conclusively presumed to be worthless, or worthless only in part, as the case may be, if the amount so charged off is not claimed as a deduction by the taxpayer at the time of filing the return for the taxable year in which the charge-off takes place."

Where a domestic building and loan association charges off a debt in obedience to a written report of a supervisory authority, the debt will be treated as properly charged off in compliance with the "specific order" provision of the above quoted regulations. See Revenue Ruling 66-335 C.B. 1966-2, 58. Where a domestic building and loan association charges off a debt in obedience to an oral instruction of a supervisory authority, the debt will be treated as charged off in compliance with the "specific order" provision of the regulations, provided the oral instructions are subsequently confirmed in writing.

To the extent that X in its final taxable year of existence charges off debts in compliance with the specific order of an authority having supervision over it, it need not include such amounts in income for such taxable year. The charges should be made to the reserves not later than the close of the final taxable year. Otherwise, the balance in the reserve accounts as of that date could not be determined.

To the extent that X's additions to its reserves for bad debts resulted in a tax benefit for prior years, the outstanding bad debt reserves must be included in its gross income for the final year of its existence.