Rev. Rul. 72-327

Advice has been requested as to the Federal income tax consequences of the transaction described below:

On July 1, 1969, corporation X merged into corporation Y in a reorganization qualifying under section 368(a)(1)(A) of the Internal Revenue Code of 1954. Pursuant to the reorganization, M corporation, a stockholder of X, received, in exchange for its X stock, Y stock having a fair market value of 100x dollars plus other property having a fair market value of 40x dollars but an adjusted basis in the hands of Y of 10x dollars. M had a basis of 90x dollars in its stock of X. M's ratable share of the undistributed earnings and profits of X accumulated after February 28, 1913, was 30x dollars. M realized gain of 50x dollars (140x dollars less 90x dollars) on the exchange. Of the 50x dollar gain, 40x dollars was recognized to M pursuant to section 356(a)(1) of the Code. Pursuant to section 356(a)(2) of the Code, 30x dollars was treated as a dividend and 10x dollars was treated as gain from the exchange of property.

The Federal income tax consequences of the above described transaction are as follows:

(1) The 30x dollar gain, treated as a dividend to M under section 356(a)(2) of the Code, is eligible for the corporate dividends received deduction provided by section 243(a) of the Code. M's basis in the stock of Y is 90x dollars. Section 358(a)(1) of the Code. M's basis in the other property received is 40x dollars, the fair market value thereof. Section 358(a)(2) of the Code.

(2) Pursuant to sections 1001 and 1002 of the Code, gain is recognized by Y in the amount of 30x dollars (40x dollars minus 10x dollars). See, for example, United States v. Thomas Crawley Davis, 370 U.S. 65 (1962), Ct. D. 1873, C.B. 1962-2, 15; E. F. Simms v. Commissioner, 28 B.T.A. 988, at 1029 (1933). Y's basis for the assets acquired from X is the basis of the assets in the hands of X. Section 362(b) of the Code.

(3) No gain or loss is recognized by X on the transaction. Section 361(b)(1)(A) of the Code.

(4) Y's earnings and profits are increased by the 30x dollar gain that it recognized on the exchange of the other property. Section 312(f)(1) of the Code. (5) Y succeeds to, and takes into account, X's earnings and profits, or deficits in earnings as of the close of the date of the transaction. Section 381(c)(2) of the Code. In computing the earnings and profits of X for purposes of section 381(c)(2) of the Code, account must be taken of the amount of X's earnings and profits properly applicable to the distribution to M. Section 1.381(c)(2)-1(c)(1) of the Income Tax Regulations. X's earnings and profits, for purposes of section 381(c)(2) of the Code, are computed as follows:

(a) X's earnings and profits are not increased by reason of the receipt of the other property. Sections 361(b)(1)(A) and 312(f)(1) of the Code.

(b) X's earnings and profits are reduced (but not below zero) by 40x dollars as a result of the distribution of the other property to M. Section 312(a)(3) of the Code. For purposes of determining earnings and profits, X is viewed as having a basis of 40x dollars (fair market value) in the other property. Section 358(a)(2) of the Code.

(6) M's earnings and profits are increased by 40x dollars, the amount of gain recognized on the transaction. Sections 356(a)(1) and (2) of the Code and section 312(f)(1) of the Code.