Rev. Rul. 70-225

Advice has been requested whether the transactions described below qualify as (1) a reorganization under section 368(a)(1)(D) of the Internal Revenue Code of 1954, (2) a distribution of stock of a controlled corporation under section 355 of the Code, and (3) a reorganization under section 368(a)(1)(B) of the Code.

R, a corporation with one shareholder, A, for many years has operated a taxicab business and a car rental business. T, an unrelated widely held corporation, desired to acquire R's car rental business. Pursuant to a plan, R transferred the assets of its car rental business to a newly formed corporation, S, in exchange for all the stock of S and distributed the stock of S to its sole shareholder (A) in a transaction intended to qualify under sections 368(a)(1)(D) and 355 of the Code. As part of the prearranged plan, A immediately exchanged all his S stock for some of the outstanding voting stock of T in an exchange intended to meet the requirements of section 368(a)(1)(B) of the Code.

Section 368(a)(1)(D) of the Code defines a "reorganization" to include a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356 of the Code.

Section 368(c) of the Code defines the term "control" as ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of each other class of stock of the corporation.

Section 335 of the Code provides rules for the distribution, without recognition of gain or loss to the shareholders, of stock of a corporation controlled by the distributing corporation.

Section 368(a)(1)(B) of the Code provides that the term "reorganization" includes the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such corporation.

Revenue Ruling 54-96, C.B. 1954-1, 111, as modified by Revenue Ruling 56-100, C.B. 1956-1, 624, discusses a situation where X corporation organized a new corporation, Y, to which X transferred one of two separate businesses X had operated in exchange for all the stock of Y. As part of a prearranged plan X transferred all the stock of Y to an unrelated corporation, Z, in exchange for 20 percent of the outstanding voting stock of Z. That Revenue Ruling holds that since the two steps were part of a prearranged, integrated, plan they may not be considered independently of each other. Consequently, since X was not in control of Y after transferring a part of its assets to that corporation, the transfer did not constitute a reorganization as defined in the predecessor of section 368(a)(1)(D) of the Code nor did it constitute a tax-free transfer under the predecessor of section 351 of the Code. That Revenue Ruling also holds that the predecessor of section 368(a)(1)(B) of the Code was not applicable, for in net effect X transferred part of its assets to Z in exchange for a part of the Z stock, rather than all the stock of a previously existing corporation.

Similarly, in the instant case, the transfer by R of part of its assets to S in exchange for all the stock of S followed by the distribution of the S stock to A and by the transfer of the S stock to T by A in exchange for T stock is a series of integrated steps which likewise may not be considered independently of each other. Accordingly, neither R nor its sole shareholder A is in control of S after the transfer and the transaction does not constitute a reorganization under section 368(a)(1)(D) of the Code nor a transfer under section 351 of the Code. Section 368(a)(1)(B) of the Code is not applicable to the transaction, since in effect R transferred part of its assets to T in exchange for a part of the T stock, rather than T having acquired all the stock of a previously existing corporation solely in exchange for its own voting stock.

Accordingly, the receipt by A of the stock of T is not a distribution to which section 355 of the Code applies. The fair market value of the stock of T is taxable to A as a distribution by R under section 301 of the Code. In addition, gain or loss is recognized to R on the transaction.