Rev. Rul. 76-188

Advice has been requested whether, under the circumstances described below, the provisions of sections 357(c)(1)(A) and 381(a) of the Internal Revenue Code of 1954 apply to a transaction that meets the requirements of both sections 351 and 368(a)(1)(C).

P corporation transferred all of the assets used in its business to newly formed S corporation solely in exchange for all the stock (voting common) of S and the assumption by S of the liabilities of P. The liabilities assumed by S exceeded the total of the adjusted basis of the property transferred by P to S. After the transfer, P remained in existence and did not distribute or intend to distribute the stock of S received in the transfer. The transaction qualified as a reorganization as defined in section 368(a)(1)(C) of the Code and it also qualified as a transfer of property to a controlled corporation within the meaning of section 351.

Section 351(a) of the Code provides, in part, for the nonrecognition of gain or loss on the transfer of property by a person to a corporation solely in exchange for stock in the transferee corporation if, immediately after the exchange, the transferor is in control of the transferee. The term "person" is defined in section 7701(a)(1) to include a corporation.

Section 368(a)(1)(C) of the Code includes within the definition of a reorganization the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of substantially all of the properties of another corporation.

Section 361(a) of the Code provides that no gain or loss will be recognized if a corporation a party to the reorganization exchanges property, in pursuance of a plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.

Section 357(a) of the Code provides, in part, that an assumption of a liability in a transaction to which either section 351 or 361 applies will not be treated as money or other property received in the exchange. However, section 357(c)(1)(A) and (B) provides, in part, that in an exchange to which section 351 or 368(a)(1)(D) applies, respectively, the amount by which the liabilities assumed exceeds the total of the adjusted basis of the property transferred will be considered as gain from the sale or exchange of a capital asset or of property that is not a capital asset, as the case may be.

Section 381(a) of the Code provides, in part, that in a reorganization defined in section 368(a)(1)(C) to which section 361 applies the acquiring corporation will succeed to and take into account the items of the acquired corporation described in section 381(c) (for example, net operating loss carryovers, and accumulated earnings and profits). Section 381(a), by its terms, is not applicable to transactions described in section 351.

The questions presented in the instant case are (1) whether section 357(c)(1)(A) of the Code is inapplicable to the transaction because of the fact that the transaction also qualifies as a reorganization under section 368(a)(1)(C) to which the provisions of section 357(c)(1)(A), by its terms, are not applicable, and (2) whether section 381(a) is inapplicable to the transaction because of the fact that the transaction also qualifies under section 351 to which the provisions of section 381, by its terms, are not applicable.

Section 368(a)(2)(A) of the Code provides that if a transaction is "described in" both section 368(a)(1)(C) and section 368(a)(1)(D), it will be treated as described only in section 368(a)(1)(D). As explained in Rev. Rul. 74-545, 1974-2 C.B. 122, the fact that a transaction does not qualify as a reorganization under section 368(a)(1)(D) does not necessarily mean that it is not "described in" that section within the meaning of section 368(a)(2)(A). A transaction is considered to be "described in" section 368(a)(1)(D) if it involves a transfer of assets to a controlled corporation and a distribution of the stock of the transferee corporation to the shareholders of the transferor corporation, regardless of whether such distribution actually qualifies under section 354, 355, or 356. In the instant case, although the assets are transferred to a controlled corporation, the transaction is not "described in" section 368(a)(1)(D) since the transferor corporation, P, did not distribute the stock of the transferee corporation to the shareholders of the transferor.

While section 368(a)(2)(A) of the Code deals with the concurrent application of section 368(a)(1)(C) and (D) to a reorganization transaction, there is no comparable provision in the Code or regulations that deals with the concurrent application of section 351 and section 368(a)(1)(C) to a transaction.

In Helvering v. Cement Investors, Inc. 316 U.S. 527 (1942), 1942-1 C.B. 185, the Supreme Court of the United States recognized that a transaction could meet the requirements of both section 112(b)(5) of the Revenue Act of 1936 (the predecessor of section 351 of the 1954 Code) and the reorganization provisions contained in section 112(a) of the Revenue Act of 1936 (the predecessor of section 368 of the 1954 Code), and that the fact that a transaction was a corporate readjustment or reorganization did not make the reorganization provisions exclusively applicable to the transaction.

Rev. Rul. 75-161, 1975-1 C.B. 114, states that section 357(c)(1)(B) of the Code contains no exception for its application where a reorganization qualifies under section 368(a)(1)(A) as well as under section 368(a)(1)(D). Therefore, since the transaction in Rev. Rul. 75-161 qualified both as a reorganization within the meaning of section 368(a)(1)(D) and as an exchange pursuant to section 361, section 357(c)(1)(B) was found to be applicable even though the transaction also qualified as a reorganization under section 368(a)(1)(A).

Likewise, section 357(c)(1)(A) of the Code contains no exception for its application where a transaction qualifies as a reorganization under section 368(a)(1)(C) as well as an exchange to which section 351 applies. Thus, in the instant case, since section 351 is applicable, section 357(c)(1)(A) applies notwithstanding that the transaction also qualifies as a reorganization under section 368(a)(1)(C).

Moreover, section 381 of the Code does not contain an exception for its application where a transaction qualifies as an exchange under section 351 as well as a reorganization under section 368(a)(1)(C). Hence, in the instant case, because section 361 applies by virtue of the exchange qualifying as a reorganization under section 368(a)(1)(C), section 381(a) applies, despite qualification of the exchange under section 351.

Accordingly, under the provisions of section 357(c)(1)(A) of the Code, to the extent that the amount of the liabilities assumed exceeds the total of the adjusted basis of the property transferred, gain is recognized to P on the transfer. Furthermore, pursuant to section 381(a), S will succeed to and take into account the items of P described in section 381(C).